We previously discussed the options available to a surviving spouse inheriting a qualified retirement account. This article will address the options available to a non-spouse beneficiary inheriting a qualified retirement account.
Just for a brief reminder, for purposes of this article, the term “retirement account” will be used to encompass all qualified retirement accounts, meaning a tax deferred retirement account such as a traditional IRA or a 401(k). Additionally, “RMDs” will be used for required minimum distributions, which are mandatory distributions for anyone who owns a qualified retirement account and has attained age 70 ½ years. The RMD is calculated according to the IRS chart, which can be found here.
A non-spouse beneficiary has the option to take the retirement account in one lump sum distribution. However, the beneficiary will have to recognize the distribution as income and pay taxes on it. If the non-spouse beneficiary wishes to keep the retirement account invested, then he or she can choose to do so through one of the options listed below.
Decedent Had NOT Reached The Age of RMD
If the beneficiary of a retirement account is a non-spouse, he or she does not have the option to roll the retirement account into his or her own IRA. The rollover option is only available to spouse beneficiaries.
Inherited IRA: A non-spouse beneficiary can roll the decedent’s retirement account into an inherited IRA that will be designated as an inherited IRA for the benefit of the beneficiary. By doing so, the non-spouse beneficiary has the option to stretch the distributions of the inherited IRA over his or her lifetime, with distributions based on his or her life expectancy from the beneficiary’s age on December 31st of the year after the decedent’s death.
5-year Rule: Another option for a non-spouse beneficiary is the 5-year rule, which requires the beneficiary to withdraw all of the assets from the retirement account by December 31st of the fifth year following the decedent’s death. The beneficiary can withdraw as much or as little in any of those given years, but at the end of the 5-years all of the assets must be withdrawn.
Decedent HAD Reached The Age of RMD
If the decedent had reached the age of RMD, the only option available to a non-spouse beneficiary, other than inheriting the account outright, is to roll the retirement account into an inherited IRA. In this scenario, the RMD can be either based off of the beneficiary’s life expectancy or the decedent’s remaining life expectancy. The latter option is typically chosen if the decedent was younger than the beneficiary, for example if the beneficiary is an older sibling or parent.
It is important to note again that a RMD must still be taken for that year of death because the decedent had attained 70 ½ years by the time of death. For example, if the decedent reached 70 ½ in February but died in June of the same year, the estate or beneficiary must take the RMD by December 31st of that year.
As is the case with a surviving spouse beneficiary, there is no 5-year rule option if the decedent had reached 70 ½ years because an RMD would be required to be taken each year and cannot be forgone.
There are additional issues when there are multiple non-spouse beneficiaries who are inheriting a retirement account. In such a case, the beneficiaries should contact a financial advisor or accountant to determine the best option available.
As mentioned before, it is important that your beneficiary designations on retirement accounts are up-to-date to ensure they will go to the correct person. To read some helpful information on conducting a thorough beneficiary review, click here.
Again, please consult with a financial advisor, accountant or attorney to determine the best available options for maximizing the benefits of the retirement account and minimizing the tax consequences.
