Any federal employee who inherited an Individual Retirement Account (IRA) from someone who died during 2022 should keep the date September 30, 2023 in mind. September 30 is an important date when it comes to IRAs in which the IRA owner named multiple beneficiaries. It is the deadline for determining whether the IRA has designated beneficiaries.
An IRA is considered to have a designated beneficiary if there are no “non-person” beneficiaries. A “non-person” beneficiary includes an estate, a trust or a charity. This determination of “non-person” beneficiary is made as of September 30 following the year of death of the IRA owner. An individual who was named as a beneficiary of the IRA by the original IRA owner and disclaims an inheritance prior to September 30 will not be considered when determining the designated beneficiaries of the IRA.
SECURE Act 1.0 passed into law in December 2019 and took effect January 1, 2020. SECURE Act 1.0 changed the rules regarding IRAs inherited after December 31, 2019.
As a result of the passage of SECURE Act 1.0, there are three classifications of IRA beneficiaries. They are: (1) Eligible designated beneficiaries (EDBs); (2) Designated beneficiaries (DBs); and (3) non-designated beneficiaries (NDB). These classifications are important in determining the timing of required distributions out of the inherited IRA. In the case of multiple beneficiaries, the classification of all beneficiaries may change if one of the multiple beneficiaries takes certain actions by September 30 of the year following the IRA owner’s or the retirement account owner’s death.
Determining the Beneficiary Classification
If there is more than one beneficiary of an IRA, then the deadline of September 30 is used to determine whether each beneficiary qualifies as a designated beneficiary. The following table summarizes who qualifies and who does not qualify as a designated beneficiary.
Another important date to keep in mind is December 31. An IRA beneficiary may be required to take a required minimum distribution (RMD) as early as December 31 of the year following the IRA owner’s death. The December 31 following the year of IRA owner’s death will depend on the beneficiary’s classification and relationship to the original IRA owner.
An IRA is considered to have designated beneficiaries if all non-person (non-designated) beneficiaries take one of the following actions by September 30 following the year of death of the IRA owner:
• Take a full distribution of their portion of the inherited assets, or
• Properly disclaim their portion of the inherited assets.
Note that a disclaimer of inherited assets must meet certain federal and state requirements.
The beneficiaries that remain after the September 30 deadline are the only beneficiaries taken into consideration when determining the beneficiary classification and timing of mandatory beneficiary IRA distributions.
The following examples illustrate the rules for multiple beneficiaries:
Example 1 (Two beneficiaries – one is a charity). Peter died at the age of 67 on July 15,2022 with an IRA valued at $500,000. His chosen IRA beneficiaries are his son Kenny (age 37) and his favorite charity. Kenny and the charity were each designated to receive 50 percent of Peter’s IRA.
Since Peter died before the required beginning date of April 1,2029 and one of his beneficiaries is a non-person (the charity), the $500,000 is subject to the five-year rule and must be distributed by December 31 of the fifth year following the year Peter died (no later than December 31, 2028).
Had Peter’s adult son Kenneth been the only beneficiary of his IRA, Kenneth would have been able to use the 10-year inherited IRA distribution rule, in which case the IRA funds would have to fully distributed by December 31 of the 10th year following the year Peter died (December 31, 2033). This would have allowed Kenneth to stretch the required distribution over 10 years rather than five years, thereby resulting in a lesser overall tax liability.
But all is not lost for Kenneth. He may still be able to use the more tax-beneficial 10-year rule if the charity:
• Takes a full distribution of its half by September 30, 2023, or
• Properly disclaims its half by September 30, 2023.
Kenneth may ask the charity to take either of these actions so that he is allowed to benefit from using the more favorable tax rule.
Example 2 (IRA owner dies after reaching her required beginning date). Sandra, age 75, died in June 2022 with an IRA worth $600,000. Sandra named her daughter Ruth and her favorite charity as 50 percent beneficiaries of her IRA. Because Sandra died after her required beginning date (April 1, 2018) and one of her beneficiaries is a non-person, post-death distributions must be taken over Sandra’s remaining life expectancy. These distributions must begin by December 31 of the year following Sandra’s death (December 31, 2023). Assume Sandra’s remaining life expectancy was 12.4 years.
Had Ruth been the only beneficiary, she would have the choice of inherited IRA distributions over a 10-year period or over Sandra’s remaining life expectancy. In this scenario, it may be more tax- beneficial for Ruth to take the distribution over her mother’s remaining life expectancy of 12.4 years. If the charity does not withdraw 100 percent of its half of the IRA (half of $600,000, or $300,000) by September 30, 2023, both beneficiaries will have to use Sandra’s remaining life expectancy in calculating the required distributions from the inherited IRA.
What is the Best Procedure to Take with an Inherited IRA?
As illustrated in the two examples, the best procedure to take with an inherited IRA depends on an individual’s circumstances. The key factors to consider are the types of entities or persons named as beneficiaries on the IRA, the age of the IRA owner at the time of death, and the respective rules around each type of beneficiary.
The most advantageous tax option is usually the one that allows the IRA funds to grow tax deferred as long as possible. If an individual is named a beneficiary on an IRA with multiple others, it is advisable to contact a tax professional for customized tax advice.
For those federal employees who were named as a beneficiary of IRAs whose owners died during 2022, there is less than a week (September 30) to decide what to do to minimize the tax liability associated with their required inherited IRA distributions. But those federal employees who were names as a beneficiary of an IRA whose owner died during 2023, the deadline to benefit from the more favorable tax treatment of their inherited IRA is one year away (September 30, 2024).