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Distribution Options For Retirement Account BeneficiariesBy: Lynn Bahler Knight, CEBS, ING Beneficiaries of retirement accounts have many options to consider when deciding when and how to receive death benefit payments. Not only does a beneficiary need to evaluate his or her own individual financial needs, the beneficiary must also be cognizant of any legal requirements for the timing and amount of those payments as well as the distribution options available under the distributing retirement plan and investment vehicle. This article discusses some of the options available to a beneficiary; however, there may be other available options and a beneficiary is urged to discuss which options would best meet his or her financial needs with his or her tax planning advisor. Timing of death payment distributions The law requires that payments from certain types of retirement accounts be made on a timely basis. These payments are commonly known as "required minimum distributions" or "RMDs." RMDs must be made from most employer-sponsored plans as well as Traditional IRAs and, upon the death of the account holder, Roth IRAs. The timing for making RMD payments during an account holder’s lifetime varies based on the plan type. Generally, for an employer-sponsored plan, that date is the later of age 70 ½ or retirement. For a Traditional IRA, that date is when the account holder reaches age 70 1/2. The law further provides that if the account holder dies before beginning to receive RMDs, a beneficiary can elect to receive payments either over 5 years or over life expectancy - but payments over life expectancy must begin no later than December 31 of year following the year of the account holder’s death. If the account holder had begun to receive RMD payments before death, generally the remaining account balance is paid over the beneficiary’s life expectancy. Note, however, for a Roth IRA, regardless of when the account holder dies, he or she is treated as having died before RMD payments had begun. "Stretching a Death Benefit" The concept of "stretching a death benefit" is an estate planning tool where death benefits are paid over a designated beneficiary’s life expectancy. If the distributing plan and investment vehicle permit, the beneficiary can name a beneficiary and payments may continue to that successor beneficiary. However, the original beneficiary’s life expectancy is used to calculate payments to any successor beneficiary. There are several potential advantages of stretching a death benefit including:
Putting a Stretch Into Action Under A Retirement Plan Let’s look at an example of stretching a death benefit under a retirement plan. Kim is a participant in a 457(b) deferred compensation plan who names her sister, Elizabeth, as her beneficiary. Kim passes away before RMDs begin. Elizabeth decides to stretch death benefit payments over her life and begins to receive annual non-annuity lifetime payments calculated under the life expectancy table provided by the Internal Revenue Service. The 457(b) plan permits a beneficiary to designate a beneficiary and therefore, Elizabeth designates her niece, Olivia, as her beneficiary. Elizabeth receives distributions for 3 years and passes away before depleting the death benefit. Olivia, as Elizabeth’s beneficiary, can choose to receive the remaining payments based on Elizabeth’s remaining life expectancy as calculated under the IRS’s life expectancy table thus continuing to stretch the death benefit. Rolling over a death benefit - spousal beneficiary A spousal beneficiary is permitted to roll over a death benefit from an eligible employer-sponsored plan to another employer-sponsored plan in which the spouse participates or to his or her own Traditional or Roth IRA. However, a spousal beneficiary needs to consider several items, including the timing and amount of taxes payable before rolling over the death benefit. For example, a spousal beneficiary may choose to delay RMD payments by rolling over the death benefit from an employer-sponsored plan to a Traditional IRA. Thus, the spouse can delay RMD payments until he or she reaches age 70 ½ as the owner of the Traditional IRA. In the alternative, a spouse may wish to roll over the death benefit to his or her own retirement plan where, as the participant, he or she can defer any RMDs until the later of age 70 ½ or retirement. Finally, a spousal beneficiary may wish to roll over the death benefit to a Roth IRA, subject to any current income limitations on Roth IRA rollovers, in order to avoid any lifetime RMDs. Of course, the spouse would always need to consider any fees and/or investment choices under an IRA vs. a retirement plan. Rolling over a death benefit - non-spousal beneficiary A non-spousal beneficiary may choose to roll over a death benefit to an inherited Traditional IRA or Roth IRA subject to any applicable income limitations and RMD requirements. For example, a non-spousal beneficiary may wish to roll over a death benefit from a retirement plan to an IRA if the retirement plan has limited distribution options, e.g., the retirement plan only provides for lump sum distributions to non-spousal beneficiaries or only provides that death benefits are paid under the 5-year rule. As noted above, the choices facing a retirement account beneficiary are complex and must be determined on an individual basis taking into consideration the beneficiary’s financial situation and the options available under the distributing retirement plan and investment vehicle. Therefore, a beneficiary is urged to discuss all available distribution options with his or her tax planning advisor before taking a death benefit from a retirement account to determine which option best fits within his or her financial plan. |
