Inherited Retirement Plan? How to Easily Understand Payout Rules
Figuring out first which kind of beneficiary you are will make it easier to grasp the rules and timing on required distributions.
With the passage of the SECURE Act, there have been changes in required payouts for beneficiaries on retirement plans and IRAs that have many people in a state of confusion.
The retirement accounts that are affected by these rule changes include 401(k) plans, 403(b) plans, 457(b) plans and traditional IRAs and Roth IRAs. And keep in mind that with all but the Roth, these required payouts will trigger taxes.
Depending on when the original retirement plan owner dies, some of these beneficiaries have to pull the money out in five years, some have to pull the money out in 10 years while taking required minimum distributions (RMDs) for the first nine years, some get to pull the money out in 10 years without RMDs over the first nine years, some get to pull the money out over their life expectancy, and there’s even a beneficiary group that gets to stretch it over their life expectancy until they reach age 21, at which time they have to switch and follow the 10-year rule.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
It’s enough to make your head explode. Is there a simple way to organize and understand these rules so the beneficiaries can be prepared to know what rules and what category both they and their loved ones will fall under? The answer is yes.
A simple way to understand the different required retirement plan payouts is to start by dividing retirement plan beneficiaries into three groups:
- Non-designated beneficiaries.
- Non-eligible designated beneficiaries.
- Eligible designated beneficiaries.
Non-designated beneficiaries, or NDBs, are easily identified because they are not people. For example, this could be an estate or a charity or a non-look-through trust.
With NDBs, if the IRA owner or retirement plan participant dies before April 1 of the year after they turn 73, better known as the required beginning date (RBD), the retirement plan proceeds must be withdrawn by the end of the fifth year after death, and there are no annual RMDs during this five-year period.
If the IRA owner or retirement plan participant dies on or after the required beginning date, RMDs must be taken over the deceased original retirement plan owner's life expectancy. This could allow for a much longer post-death payout than five years, which could help minimize taxes.
The next category, non-eligible designated beneficiaries (NEDBs), will represent the largest group of beneficiaries. This group includes adult children who are 21 years of age or older and grandchildren.
With NEDBs, if the original retirement plan owner dies before the required beginning date, there are no annual RMDs, but all the money must be withdrawn by the end of the tenth year after the original owner's death, with taxes applied. This is known as the 10-year rule.
For this same group, if the original owner dies on or after the required beginning date, then there will be annual RMDs based on the beneficiary’s life expectancy that must be taken for years one to nine with the entire account to be emptied by the end of the 10th year after death, with all applicable taxes applying.
The final category of beneficiaries, the eligible designated beneficiaries (EDBs), have the sweetest deal since they are exempt from the 10-year rule, which means they can take their RMDs based on their life expectancy, which will normally result in a much smaller taxable distribution.
The two biggest groups that have this status would be a surviving spouse or a beneficiary not more than 10 years younger than the IRA owner, like a brother or sister. This can also include a beneficiary who’s older than the original IRA owner.
Other groups would include disabled individuals, chronically ill individuals and minor children of the original retirement account owner until they reach age 21, at which time the 10-year countdown would apply.
So that’s it. You can now identify which group you fall under and make sure you take your required retirement plan payouts appropriately to avoid penalties or paying unnecessary tax.
And while you’re at it, consider doing some planning on what you or your heirs can do to maximize the tax efficiency of your future withdrawals.
For example, while the original IRA owner is still alive, he or she might consider doing Roth conversions since the withdrawals would be tax-free for their heirs.
If you’re charitable-minded, consider leaving more of the pre-tax retirement money to a charity (a non-designated beneficiary) since the charity receives the funds tax-free. Then you could leave more of the non-retirement accounts to the heirs, which would trigger far less tax on withdrawals.
And remember: Even if the beneficiary has already inherited the IRA, regardless of which of the three categories they fall into, they can always take out more than the RMD, which if done in years where they fall into a lower tax bracket, can reduce the overall tax impact.
To continue reading this article
please register for free
This is different from signing in to your print subscription
Why am I seeing this? Find out more here
-
Is a Phased Retirement Right for You?
Want to keep working, just not as hard? A phased retirement may just be the answer.
By Kimberly Lankford Published
-
Four Tips to Make Your Sales Presentation a Winner
Being prepared and not being boring can go a long way toward persuading a potential customer to buy into what you’re offering.
By H. Dennis Beaver, Esq. Published
-
Four Tips to Make Your Sales Presentation a Winner
Being prepared and not being boring can go a long way toward persuading a potential customer to buy into what you’re offering.
By H. Dennis Beaver, Esq. Published
-
Pros and Cons of Waiting Until 70 to Claim Social Security
Waiting until 70 to file for Social Security benefits comes with a higher check, but there could be financial consequences to consider for you and your family.
By Patrick M. Simasko, J.D. Published
-
Now Could Be Time for Private Investors to Make Their Mark
The venture capital crunch may be easing, but it isn't over yet. That means there could be direct investment opportunities for private deal investors.
By Thomas Ruggie, ChFC®, CFP® Published
-
How to Stop Boredom From Ruining Your Happy Retirement
Retirees who explore new interests and have an active social life are more likely to find joy — and even greatness — in the newfound freedom of retirement.
By Richard P. Himmer, PhD Published
-
The Life-or-Death Answers We Owe Our Loved Ones
How our life ends isn’t always up to us, but that question too often must be answered by loved ones and health care workers who don’t know what we would want.
By Joel Theisen, RN Published
-
Hot Tips for Home Buyers and Sellers Right Now
Real estate looks to be especially hopping this spring, thanks to pent-up demand and buyers adjusting to higher mortgage rates. Here’s how you can prepare.
By Pam Krueger Published
-
Is 100 the New 70?
Eating well, exercising, getting plenty of sleep and managing chronic stress can help make you a SuperAger. Funding that long life requires longevity literacy.
By Phil Wright, Certified Fund Specialist Published
-
Nine Lessons to Be Learned From the Hilton Family Trust Contest
Disclaimers, good communication, post-marital agreements and more could help avoid conflict in a family after the owners of a wealthy estate pass away.
By John M. Goralka Published