Distributions, Transfers & Rollovers

Understanding Beneficiaries

Beneficiary Terms & Concepts

Excess Accumulation Penalty: The IRS gets 50% of what should have been distributed if the owner fails to take his or her RMD at anytime during the life of the IRA.

Inherited IRA: This is a term used to describe an IRA rolled into the name of a beneficiary for distribution and tax reporting purposes. An inherited IRA cannot accept any subsequent contributions of any kind. Distributions from inherited IRAs are always coded as death distributions until the account is consumed. The funding of the inherited IRA, however, is a non-taxable transfer from the original owner's IRA.

Inherited IRA Account Styling: "Sonny N. Rich, Beneficiary of Daddy D. Rich IRA" (non-personal name). The beneficiary is the sole owner of the account. Tax reporting is under the beneficiary's name and SSN.

IRA Death Distributions: Any distribution into the actual hands of a beneficiary after an IRA owner dies should be reported under the beneficiary's name and tax ID number (SSN) as a death distribution from an inherited IRA. Beneficiaries are responsible for the tax consequences. The following beneficiary information is required:

• Full Name of the beneficiary (the one who is responsible for the taxes)
• Physical street address
• Mailing address (if different)
• Tax ID Number (usually the SSN)
• Distribution method
• ID, such as a driver's license number, issuing state, issue date, and expiration

Beneficiary Terms & Concepts continued . . .

Beneficiary does not want IRA Money: We require the beneficiary to legally disclaim the IRA with the help of an attorney.  This legal document allows the bank to replace the primary beneficiary with someone else (usually a contingent beneficiary).

One IRA Owner,  but two sets of Beneficiaries (think step-children):  The IRA owner should maintain two or more separate IRAs, each one with its own set of beneficiaries.   This eliminates questions about how funds should be divided among two different families.

Separate Accounting: Splitting the IRA of the deceased into separate IRAs for each beneficiary using inherited IRA account styling (a non-personal name). December 31 of the year following the IRA owner's death is the deadline for separate accounting to preserve distribution options favorable to each beneficiary.

Tax Consequences - Traditional IRA: Death distributions from a traditional IRA generally result in a tax liability for the beneficiary. Impact can be minimized by spreading distributions over several years. Moreover, because distributions are coded as death distributions, recipients avoid the additional 10% penalty regardless of age.

Tax Consequences - Roth IRA: Roth IRA death distributions are generally tax free, meaning they do not result in a tax liability except in one circumstance. That one circumstance comes into play if the original owner dies before completing his 5-year holding period. More will be said about this later in this module. Moreover, the original owner is never required to take a minimum distribution, and all distributions to beneficiaries are said to start before the Required Beginning Date (RBD).

Spousal Consent:  Utah is one state that does not require the spouse to sign a consent form when the IRA owner designates a non-spouse primary beneficiary.  However, a best practice is to always attempt to get the spouse's acknowledgement in writing when this is the case.  The IRA Organizer has a spousal consent section.   Note that most other retirement plans (such as SBSU's 401(k) require the spouse's consent if the owner wants someone else to be the beneficiary.

Treat As Own: This option is available to a spouse beneficiary. Here, the surviving spouse rolls her deceased husband's IRA directly into her own and treats it as her own. Moving IRA money under this option is not a tax-reportable event. This option will be discussed later in this module.

When Death Distributions Must Begin: December 31 of the year following the IRA owner's death, regardless of the age of the beneficiary. The only exception is the spouse beneficiary under Treat as Own provisions

Beneficiaries - Owner not in RMD

"Not in RMD" means the owner is not required to take minimum distributions because he died before April 1 in the year following his 70½ birthday. In other words, he died before his RBD (required beginning date).

The primary beneficiaries and their relationship to the deceased needs to be determined. Contingent beneficiaries are not considered unless all of the primary beneficiaries are deceased before the owner dies. Options are as follows:

One Spouse Beneficiary and she selects "Treat as Own": See Treat as Own.

Multiple or Non-spouse Beneficiaries or Multiple Distributions: If necessary, SBSU will create inherited IRAs for each beneficiary to preserve separate accounting, each account styled similar to the following: "Sonny Smith, Beneficiary of Mommy Smith IRA". Non-spouse beneficiaries cannot co-mingle inherited IRA funds with personal IRA money. Subsequent actions include the following:

• Money is transferred into each inherited IRA. The original account should have a $0 balance when finished.
• Appropriate distribution methods are arranged (explained later).
• Distributions from each inherited IRA must begin no later than 12/31 of the year following the owner's death, all coded as death distributions. The only exception is the spouse beneficiary who may transfer her portion into her own IRA under treat as own provision (details later).
• Further contributions to the account are not allowed.

Beneficiaries - Owner in RMD

"In RMD" means the owner died on or after April 1 of the year following his 70½ birthday. Here, the beneficiaries must fulfill the owner's RMD for one year only. After the RMD is fulfilled, each beneficiary may switch to the distribution option available for his or her circumstance. Procedures are as follows:

Calculate the RMD for the Deceased: Use the age the owner would have attained in the year of death. This amount must be paid by the beneficiaries from their inherited IRAs by dividing it among themselves. Or, one beneficiary may fulfill the RMD, leaving the others off the hook. More than the RMD may be distributed, but not less. Procedures should be followed in order, as follows:

• Inherited IRAs for each beneficiary is created under separate accounting. Account styling should be "Lulu Smith, Beneficiary of Thomas Smith IRA".
• Money is transferred money into each inherited IRA.
• Each beneficiary is the sole owner of the account.
• Tax reporting is under each beneficiary's SSN.
• Calculate the owner's RMD using the same distribution method used in previous years and fulfill it from one or more of the inherited IRAs. More than the RMD may be distributed from among the plans but not less. Distributions are coded as death distributions.
• After the RMD is fulfilled, beneficiaries may switch to a method they elect for their subsequent death distributions (explained later). SBSU must know the owner's distribution choice by 12/31 of the year following the owner's death.

Distribution Methods Explained

Lump Sum Distribution: This is the most straightforward distribution method available, popular with both traditional and Roth beneficiaries. Lump sum is exactly what it sounds like - the beneficiary takes everything as a death distribution in one transaction. The beneficiary of a traditional IRA is responsible for taxes. It is popular because (a) it gets the distributions over with quickly, (b) any beneficiary may use it, and (c) everyone understands it. Lump sum death distributions are made under the beneficiary's SSN from an inherited IRA.

Five Year Rule: This is another popular distribution method for traditional and Roth beneficiaries. With this option the beneficiary has five years to take death distributions. The five year period can be thought as anniversary years. The death distributions must be completed by the end of the fifth anniversary year. For example, if 2002 is the year death, all distributions must be completed by the end of 2007. A beneficiary is not required to take equal amounts each year. Distributions may be taken according to any whim or reason during the five year period so long is the money is gone at the end of the period.

Five Year Rule and Roth Beneficiaries: Roth beneficiaries often use this option to fulfill the owner's 5-year holding requirement to allow for distributions that are completely tax free. For example, let's say an IRA owner converted a large amount of money to his Roth in 2004. Let's also say this owner dies in 2006. The beneficiary must wait until 2009 to take a lump-sum distribution that is completely free of possible taxes and penalties. The funds must be completely distributed by 2011. The 5-year option allows the beneficiary to take smaller tax-free distributions during the first few years of previous contributions (remember Roth ordering rules). Larger distributions of earnings may be taken after the 5-year mark.

Single Life Expectancy - Owner Not in RMD

The single life expectancy table is used in death distribution cases. Look up the value for a person who is 70 years old. It should be 17.0. In other words, a person 70 years old may expect to live another 17 years (if he hadn't died). This option is often selected because it has the longest pay out available to non-spouses, trusts or estates. Before using this option the IRA should be converted into an inherited IRA under the beneficiary's name. Distributions are all coded as death distributions. Again, the following applies when the owner is not in RMD at the time of death.

Spouse Beneficiary: A spouse beneficiary may delay distributions until the year the original owner would have attained 70 ½ and then take distributions according to the longest life expectancy - his or hers. For example, if Jack died on his 65th birthday on June 2, 2006, his spouse could delay distributions until 2011, the year Jack would have turned 70 ½. The only question is which life expectancy should be used to calculate the RMD?

• The surviving spouse is younger: If Jack's widow turns 67 in 2011, her life expectancy is 19.4. Jack's, at that same time is 17.0. His widow, then could take a 2011 death distribution by dividing her factor (19.4) into the value of the IRA as of 12/31/2010. The next year she would reduce her factor by one (19.4 - 1 = 18.4) and divide that into the IRA value as of 12/31/2011. She would continue reducing the factor by one for each year of distribution until the IRA is consumed.
• The surviving spouse is older: This is where the single-life expectancy is often used. For example, let's say the surviving spouse is 80 and in good health when his spouse (65) passes away. Distributions may be delayed until the deceased IRA owner would have turned 70 ½. and a Single Life Expectancy of 17. The survivor's, who is now 85, is 7.6. The survivor may continue to use the original owner's factor for the first distribution, reducing the factor by one for each year of distribution until the IRA is consumed.