Texas Bar Journal • January 2024

Designated Beneficiaries of Individual Retirement Arrangements

Navigating the rules that govern distributions so lawyers can better advise their clients.

Written by Jim Norman

Individual Retirement Arrangements, or IRAs, often pass through beneficiary designations, making them non- probate assets. Nevertheless, an IRA owner may wish to designate a trust or estate as a beneficiary for estate planning reasons, making the account part of the client’s estate plan. And even a client in a probate matter may ask for advice in administering an IRA that bypasses an estate. For these accounts, naming a beneficiary has implications beyond determining who gets the funds in the IRA. It may also determine how quickly those funds must be withdrawn (and thus income-taxed) after the account owner’s death.

This article will focus on the rules governing distributions to designated beneficiaries of IRAs, so that lawyers can better advise their clients on these matters. Note that these rules are in flux—Congress has enacted legislation in recent years amending some of these provisions, and the IRS in February 2022 proposed amendments to the treasury regulations affecting distributions.¹ In some instances, which rules apply depend on the law in effect as of the decedent’s date of death. We will touch on some of the proposed rules, but space does not allow for a thorough explanation. The proposed regulations also include new definitions of see-through trusts, conduit trusts, and accumulation trusts, which should help in planning by providing clarity on the IRS’ understanding of those terms.²

The rules explained here are general rules; many exceptions exist. For example, IRA plan provisions may restrict elections available to beneficiaries, and the surviving spouse distribution rules are very involved. Seeking the advice of experts is highly encouraged!

We begin with a review of the basics of IRA transfers to designated beneficiaries: A beneficiary generally has limited time to withdraw the assets of a decedent’s IRA without facing hefty penalties. One big exception is a surviving spouse, who has much more flexibility than a non-spouse beneficiary, and in many cases can simply become the owner of the IRA outright.

Let’s start with a review of the rules governing distributions by non-spouse beneficiaries.

WHO IS CONSIDERED A BENEFICIARY OF THE IRA?
A beneficiary is a person or entity named by the account owner to receive funds upon the account owner’s death.

Different rules apply regarding distributions depending upon whether the recipient is a “designated beneficiary,” an “eligible designated beneficiary,” or a beneficiary that falls into neither of those categories. An individual, including a surviving spouse, is considered a “designated beneficiary” of a decedent’s IRA if 1) the individual is named by the owner as a beneficiary of the IRA on the decedent’s date of death; and 2) the individual is still a beneficiary on September 30 of the year following the year in which the decedent died (e.g., the individual has not disclaimed the benefit or already received the entire benefit).³

Some beneficiaries are also “eligible designated beneficiaries.” An individual is an eligible designated beneficiary if the individual is the decedent’s surviving spouse, minor child (but not a grandchild or other minor), a disabled individual, a chronically ill individual, or any other individual who is not more than 10 years younger than the decedent.⁴

WHEN MUST DISTRIBUTIONS BEGIN, AND HOW MUCH MUST THEY BE?
The start date of mandatory distributions—known as “required minimum distributions,” or RMDs—to the beneficiary depends first on whether the decedent died before or after the “required beginning date” of the decedent’s distributions. The required beginning date is April 1 of the year after the year the owner turns 72.⁵ For individuals turning 72 after December 31, 2022, and turning 73 before January 1, 2033, the applicable age is 73.⁶

If the decedent died before the required beginning date, an eligible designated beneficiary may elect to take distributions either under the “10-year rule” (see below) or by using the beneficiary’s life expectancy listed in the Single Life Table at Treas. Reg. § 1.401(a)(9)-9(b).7 (All of the tables for life expectancy determinations are also in IRS Publication 590-B, at https://www.irs.gov/forms-pubs/about-publication- 590-b.). Note that the beneficiary’s options for making distributions may be limited by the IRA plan’s provisions.⁸ A beneficiary who is not an eligible designated beneficiary only has the option to take distributions under the 10-year rule.⁹

Under the 10-year rule, a beneficiary must take all distributions—the entire balance of the IRA—by December 31 of the year of the 10th anniversary of the decedent’s death (e.g., if the decedent died in 2023, all distributions must be made by December 31, 2033). No distributions are required before the 10th year.¹⁰

If the beneficiary uses the Single Life Table at Treas. Reg. § 1.401(a)(9)-9(b), distributions must begin within one year of the decedent’s death.¹¹ To use the Single Life Table, find the life expectancy to the right of the beneficiary’s age as of the birthday in the year of distribution, and divide the total assets in the IRA as of December 31 of the previous year by the life expectancy.¹²

Ex: Beneficiary turns 70 years old in 2023, and the IRA’s assets on December 31, 2022, totaled $100,000— The RMD for 2023 is $100,000 /18.8, or $5,319.

For each subsequent year, calculate the RMD by reducing the life expectancy by one.¹³

If the IRA owner died on or after the required beginning date, a distribution must be taken during the year of the decedent’s death; the amount of the RMD is the amount the decedent must have taken during the year of death. If the decedent took less than the RMD for the year, the beneficiary must take the remaining portion of the RMD.¹⁴ In following years, an eligible designated be-neficiary determines the RMD based on the longer of the beneficiary’s life expectancy from the Single Life Table at Treas. Reg. § 1.401(a)(9)-9(b) or the owner’s life expectancy from the same table, using the owner’s age on the owner’s birthday in the year of death.¹⁵

Other designated beneficiaries—a designated beneficiary who is not an eligible designated beneficiary—must take distributions under the 10-year rule described above, regardless of whether the IRA owner died before or after the required beginning date.¹⁶ Note that the proposed regulations require annual distributions to be taken in this instance beginning in the calendar year following the decedent’s death (based on the beneficiary’s life expectancy); they may not be delayed until the end of the 10-year period.¹⁷

SURVIVING SPOUSES AS BENEFICIARIES
A surviving spouse who is the designated beneficiary of an IRA has more options than a non-spouse beneficiary. The spouse may in some instances become the IRA’s owner, may roll the IRA over into a different retirement plan, or may elect to be treated as the beneficiary of the IRA and follow similar rules as other eligible designated beneficiaries.¹⁸ In some cases, the IRA will be deemed to be the spouse’s own.¹⁹ If a spouse becomes the IRA’s owner, the normal withdrawal rules for IRA owners apply, not the rules for IRA beneficiaries.²⁰ The many complexities of the rules governing spouses as beneficiaries are beyond the scope of this article; professional tax advice is necessary.

MULTIPLE BENEFICIARIES
If there is more than one beneficiary, and all beneficiaries are individuals, the designated beneficiary is the individual with the shortest life expectancy, and RMDs for the account are calculated using that beneficiary’s life expectancy.²¹ Provisions exist, however, for splitting IRAs into separate accounts or shares for each beneficiary, with required minimum distributions calculated for each separate account or share based on the respective beneficiary’s life expectancy. To achieve this result, the separate accounts or shares must be established by the end of the year following the year of the decedent’s death.²²

ESTATES AS BENEFICIARIES
An estate or other entity that does not have a life expectancy can be neither a “designated beneficiary” nor an “eligible designated beneficiary.” As a result, it must use different rules. For estates named as beneficiaries, refer to the Single Life Table to find the life expectancy used to determine the required minimum distribution. Use the decedent’s age on the birthday in the year of death, subtracting one from the life expectancy for each year beginning on the year after death.²³ If the decedent died before the required beginning date, use the “5-year rule” instead—the estate must take distributions to exhaust the entire balance of the IRA by December 31 of the year of the fifth anniversary of the decedent’s death (e.g., if the decedent died in 2023, all distributions must be made by December 31, 2028); no distributions are required before the fifth year.²⁴

TRUSTS AS BENEFICIARIES
Like an estate, a trust does not have a life expectancy. Nevertheless, in certain circumstances, a trust may be able to defer distributions if the trust qualifies as a “see-through” trust. If all of the trust’s beneficiaries are individuals and certain other requirements are met, the trust is not considered a beneficiary for purposes of calculating RMDs. Generally, for a see-through trust look to the beneficiaries of the trust in doing the math on RMDs.²⁵ Non-see-through trusts are treated similarly as estates.²⁶

ROTH IRAs
The minimum required distribution rules do not apply to Roth IRAs during the account owner’s lifetime, but they do apply to beneficiaries of Roth IRAs after the account owner’s death. The eligible designated beneficiary of a Roth IRA must take RMDs based on his or her life expectancy from the Single Life Table or may elect to use the 10-year rule.²⁷ Any other designated beneficiary must take distributions based on the 10- year rule.²⁸ As with traditional IRAs, a surviving spouse has additional options not available to other beneficiaries.²⁹

TAXATION OF DISTRIBUTIONS
While contributions to traditional IRAs are generally made tax-free, distributions to IRA owners and their beneficiaries are taxed as gross income.³⁰ Taxation of distributions to beneficiaries from Roth IRAs is often zero but may depend on whether the distributions are deemed as contributions of the owner or as earnings on those contributions.³¹

Always a complex topic, recent and ongoing changes to the Internal Revenue Code and to IRS regulations have made advising clients on taking distributions from a decedent’s IRA even more treacherous. Luckily, the advice often given—“the IRS may want you to take distributions based on the decedent’s age, not yours; talk to your accountant”—will still be good counsel.

JIM NORMAN is a native of Austin. He practices estate planning, probate, and guardianship law in his hometown.