Post-Death Required Minimum Distributions

In yesterday’s post, I summarized how death affects your retirement accounts. An important component of that, left hanging, are the Required Minimum Distribution (RMD) rules that apply to your account. What’s the minimum amount that must be taken by your beneficiary each year?

First let me set the scene. Your spouse died years ago. (If your spouse is alive, chances are pretty good she is your beneficiary, and she will do a rollover as described in March 17’s post. Then this whole discussion will apply to her retirement account after her death.) You have named your child as beneficiary. You die. Quel dommage. Here are the rules that govern your child’s Required Minimum Distributions.

General Rule. Each year, beginning with the year after your death, your child must take at least a certain minimum amount. As in life, that minimum is determined by dividing the account’s January 1 value (or the day before’s value) by a divisor.

The divisor in that first year after your death is the child’s life expectancy, which can be found in Table I of Appendix C to IRS Publication 590, which can be found on the IRS’s website, here: http://www.irs.gov/pub/irs-pdf/p590.pdf. This is the only number your child has to look up. Every year following that first year after your death, your child simply reduces the divisor by one. It eventually reaches zero, and the account will be depleted in that final year.

For example, if your child attains age 45 in the year after the year of your death, the appropriate divisor starts out at 38.8. Then the next year it’s 37.8, then 36.8, and so on. Your child gets to stretch out distributions for 39 years. It’s like you’ve bequeathed her a source of retirement income, only one that starts now rather than age 65. What a nice parent you are!

Five Year Rule. There’s an alternative option that applies to all Roth accounts, and to traditional retirement accounts where the owner died before the date his lifetime RMD’s were required to begin. In that case, instead of stretching out distributions over his life expectancy, the beneficiary can take distribution of the whole account by the end of the fifth year after the year of your death. It can be sprinkled out over that six calendar year period, or taken all at once. Remember, this Five-Year Rule is an option, and it’s usually inferior to the General Rule.

Multiple Beneficiaries. What if you have named multiple children as beneficiary? Then as long as they split up the retirement account, they can each determine their RMD based on their individual life expectancy. And splitting the account is something they will want to do anyway, to eliminate a potential avenue for sibling strife.

Other Individual Beneficiary. What if the beneficiary is a human other than a child? If your surviving spouse is the beneficiary, she gets options not offered to other humans, the most important of which is the right to roll over your account into an IRA of her own, as described in March 17’s post. If the beneficiary is a human being other than your spouse, such as a domestic partner, they are treated the same as a child. But of course their own life expectancy governs their RMD’s.

Grandchild as Beneficiary. What if your beneficiary is your grandchild? Congratulations! You’ve just accomplished some clever tax planning. Grandchildren are treated the same as children, except that they tend to have a much longer life expectancy. For example, a 25-year old grandchild is given 58.2 years over which to stretch out distributions compared to 38.8 years for a 45-year old. The tax benefits can be impressive.

Non-Human Beneficiary. What if you’ve named your estate, or a trust, or some other non-human beneficiary? Then your beneficiary’s RMD’s depend on when you died and the type of account you’ve got. In either case, the required distribution period gets severely truncated. Here are the two possibilities:
1. Roth Retirement Account, or Death Occurs Before RMD’s Required to Begin. In this case, your non-human beneficiary must take distributions in accordance with the Five Year Rule described above.
2. Traditional Retirement Account, and Death Occurs After RMD’s Required to Begin. In this case, your non-human beneficiary must take minimum distributions over your remaining life expectancy. Huh!? Come again? Aren’t we assuming here that you just died? What’s your life expectancy when you’ve just died? Well, the IRS says you’ve got one. You may not have a pulse, but you’ve got a life expectancy. Look up the single life expectancy (in that table in IRS Publication 590) for someone of your attained age in the year of your death. Then subtract one for each year that has elapsed. For example if you die in 2010 and you would have attained age 80 that year, the single life expectancy for an 80-year old is 10.2. So your beneficiary’s divisor in 2011 is 9.2; in 2012 it’s 8.2; and so on.

It all sounds pretty morbid to me. In tomorrow’s post, I will explore the implications of the General Rule.