Compliance Article

04/18/2008

Phil Royce Consultant, IRAs and HSAs, Wolters Kluwer Financial Services

May an individual retirement account (IRA) beneficiary name a beneficiary—a successor to receive any remaining assets upon the beneficiary’s death?  What are the benefits of doing so?

The final required minimum distribution (RMD) regulations and Article IV of the Internal Revenue Service (IRS) model IRA forms (Forms 5305 and 5305-A) provide the rules for distributions to successor beneficiaries. However, the regulations and model forms do not indicate whether a beneficiary can actually name his/her own successor beneficiary, or if the default provisions of the regulations and/or IRA agreement apply. Because of this silence, an IRA agreement, an amendment, or an addendum to an IRA agreement could allow such designations, subject to state laws. Users of Wolters Kluwer Financial Services’ IRA agreements should have a written policy to permit these designations, which must comply with state laws.

An IRA owner’s death before or after his/her required beginning date (RBD) and whether the original beneficiary is the IRA owner’s spouse, will determine a successor beneficiary’s distribution options. Let’s look at some examples.

Death of IRA owner before the RBD, spouse beneficiary

Example 1.1
John died in 2007 at age 58, leaving his 55-year-old wife Mary as his sole IRA beneficiary. Mary chose to take distributions over her single life expectancy beginning no later than December 31 of the year John would have turned age 70½ (2019). Assume that Mary will die in 2020, after the date on which she was required to begin distributions. Mary named her son Fred, age 30, as successor beneficiary of her interest in John’s IRA.

Upon her death, Fred would use Mary’s single life expectancy, fixed in the year of Mary’s death, and reduced by one for each subsequent year to determine his required distributions. Mary would have been age 68 in 2020, so the life expectancy divisor for 2020 would be 18.6. If Mary had not taken her distribution for 2020 before she died, Fred would have to take that distribution by December 31, 2020. In 2021, Fred would have to take a distribution using a life expectancy divisor of 17.6.

Example 1.2
Assume the same facts as Example 1.1; however, Mary dies in 2012, before the date when she would have been required to begin distributions from her husband’s IRA. Under the regulations, Fred has the option of using the five-year rule or his own single life expectancy. With his life expectancy, distributions would begin by December 31, 2013. Fred, who would reach age 36 in 2013, would use a life expectancy of 47.5, reduced by one for each subsequent year. 

Note:  Although the five-year rule in this Example 1.2 comes from a reading of the RMD regulations, IRS model Form 5305 (used in Wolters Kluwer Financial Services’ IRA Organizers) does not allow an individual successor beneficiary to use the five-year rule.

Example 1.3
Assume Mary names the American Red Cross as her successor beneficiary instead of Fred, and dies after the date she would have been required to begin distributions from her husband’s IRA (December 31, 2019). The American Red Cross could calculate required distribution amounts based on Mary’s single life expectancy, fixed in the year of her death, and reduced by one for each subsequent year.

If Mary were to die in 2012, before the date she would have been required to begin distributions from her husband’s IRA, the American Red Cross would have to use the five-year rule, with all assets distributed by December 31, 2017.

Death of IRA owner before the RBD, nonspouse beneficiary

Example 2.1
Bill died in 2007 at age 66, leaving his son Michael, age 40, as his beneficiary. Michael named his wife Susan as successor beneficiary. Michael chose the life expectancy option and must begin taking required distributions by December 31, 2008, calculated using his own single life expectancy (42.7 in 2008), and reduced by one for each subsequent year (41.7 in 2009, 40.7 in 2010, etc.). If Michael dies before taking his entire share of Bill’s IRA, then Susan would continue to take required distributions using Michael’s life expectancy schedule. Susan does not have the option of using her own life expectancy, nor can she choose the five-year rule or treat the IRA as her own.

Example 2.2
Assume the same facts as Example 2.1; however, Michael elects the five-year rule. In this case, his election of the five-year rule applies after his death, and Susan must remove all of the assets in the IRA by December 31, 2012.

Death of IRA owner after the RBD, spouse beneficiary

Example 3
Jane died in 2007 at age 74, leaving her husband Sam, age 73, as her sole primary beneficiary. Sam named his son James as successor beneficiary. Unless Sam treats Jane’s IRA as his own, he is required to take distributions under the life expectancy method, to begin by December 31, 2008. Sam’s attained age on the Single Life Expectancy Table will determine the divisor for calculating each year’s required distribution. The divisor for 2008 is 14.1 (Sam is 74).

Sam dies in 2010 before taking his required distribution, with a life expectancy for 2010 of 12.7 (age 76). James must take Sam’s required distribution amount by December 31, 2010. In 2011, James will apply the reduction method and use a life expectancy of 11.7 to calculate his RMD. In 2012, he would use 10.7, etc.

Death of IRA owner after RBD, nonspouse beneficiary

Example 4
George died in 2007 at age 76, leaving his daughter Jennifer, age 40, as his primary beneficiary. Jennifer named her daughter Barbara as successor beneficiary. Jennifer’s only option as a nonspouse beneficiary is to use her own single life expectancy, beginning the year after George’s death, to calculate her required distribution amounts. In 2008, Jennifer would use 42.7 to calculate her RMD. In 2009, she would apply the reduction method and the divisor would be 41.7. In 2010, the divisor would be 40.7, etc.

If Jennifer dies in 2010, after taking her 2010 required distribution, her daughter Barbara must begin taking distributions by December 31, 2011, using Jennifer’s distribution schedule. Barbara’s divisor for 2011 would be 39.7.

Documenting a Successor Beneficiary Designation
Wolters Kluwer Financial Services’ Beneficiary IRA Designation or Change of Successor Beneficiary form allows a beneficiary to designate multiple successor beneficiaries. The form also allows for the designation of contingent successor beneficiaries.

A financial organization using one of Wolters Kluwer Financial Services’ Beneficiary IRA Organizers will also find the successor beneficiary designation on the application page of the Organizer. A financial organization may indicate that it does not allow the designation of successor beneficiaries by checking the appropriate box on the application.

Tax Reporting for Successor Beneficiaries
Financial organizations must properly report distributions from beneficiary IRAs to the IRS and to IRA beneficiaries. Any distributions paid to IRA beneficiaries are reported as death distributionsIRS Code 4 on Form 1099-R for traditional and Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) IRAs, Code T or Q as appropriate for Roth IRAs. In any year a beneficiary has assets remaining in a beneficiary IRA, the financial organization must issue a Fair Market Value statement and Form 5498 in the name of the beneficiary, or successor beneficiary if applicable, as beneficiary of the original deceased IRA owner.

Example 5
Charles Rivenhall had an IRA with ABC Bank. Charles named his wife Sophy as beneficiary of the IRA. When Charles died, Sophy named her daughter Amabel as successor beneficiary. The Form 5498 tax reporting for the year of Sophy’s death and subsequent years would read “Amabel, bene of Charles” under Amabel’s taxpayer identification number.

Benefits
The ability to name successor IRA beneficiaries is a benefit to all involved. The original beneficiary’s estate does not have to recognize the remaining assets as income (although the date-of-death value is included in the value of the deceased’s estate). Successor beneficiaries can continue tax deferral by taking distributions over time rather than as a lump sum. Financial organizations can benefit when the IRA assets remain on deposit.

Financial organizations should investigate state law and develop policies regarding the designation of successor beneficiaries. Options for distribution to successor beneficiaries vary, and depend on whether the original IRA owner died before or after his/her RBD, and the relationship of the original beneficiary to the deceased IRA owner. Wolters Kluwer Financial Services’ beneficiary forms document the designation of successor beneficiaries, and collect information necessary for proper tax reporting.