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Now that we have covered how you can protect the assets of your heirs’ inherited IRAs, it’s time to move on to the rules for withdrawing assets from an inherited IRA. Our last article will cover pros and cons of creating a Retirement Plan Trust to be the beneficiary of an IRA.

What Rules Apply?

The rules on how rapidly withdrawals must be taken from an inherited IRA differ depending on who or what the beneficiary is. There are a series of questions that guide that determination.

Question Number One – Can the Account Be Divided into a Separate Account for Each Beneficiary?

If, under the beneficiary designation, before December 31 of the year following that of the participant/owner’s death a separate account can be and is established for each beneficiary, a separate determination will be made for each account. If, however, the separation cannot be made, the distribution rule that applies to the whole account is the one that would be applicable to the least privileged beneficiary.

Question Number Two – Is There a “Designated Beneficiary”?

The least stretch opportunity is afforded to the beneficiary that is or the class of beneficiaries that contains a beneficiary that is other than a “designated beneficiary.”

A “designated beneficiary” is a beneficiary who is:

  • named as a beneficiary under the terms of the plan or by an affirmative election by the
  • owner/participant; and
  • an individual who is alive on the owner/participant’s date of death.

A “designated beneficiary”:

  • need not be specified by name, but must be identifiable on the owner/participant’s date of death;
  • may be a member of a class of beneficiaries capable of expansion or contraction (e.g., my children or grandchildren) so long as the members of the class may be determined on the owner/participant’s date of death; and
  • may be an individual among those named as beneficiaries of a “qualifying trust.”

To be a “qualifying trust,” a trust must meet four simple requirements:

  1. It must be valid under state law;
  2. It must be irrevocable upon death of owner;
  3. All beneficiaries of the trust must be identifiable from the trust instrument; and
  4. The Trustee must provide a copy of the trust to the plan or IRA custodian by October 31 of the year following the participant/owner’s death.

Examples of named beneficiaries that cause the “designated beneficiary” question to be answered in thenegative are the owner/participant’s estate, a charity, an entity (e.g., a corporation, partnership, or LLC), and an individual who was not alive at the death of the participant.

The “designated beneficiary” determination has to be made by December 31 of the year following that of the participant/owner’s death. If there is a designated beneficiary then the Life Expectancy Rule applies. If not, then the Five Year Rule applies.

Life Expectancy Rule

If the Life Expectancy Rule applies, the beneficiary’s RMD in the year following the owner/participant’s death will be an amount equal to the account balance on the December 31 following the owner/participant’s death divided by the beneficiary’s actuarial life expectancy, as determined by the IRS Single Life Table, at the time of the owner/participant’s death. The first RMD withdrawal must be taken by the December 31 following the first anniversary of the owner/participant’s death.

In each subsequent year, the beneficiary’s RMD will be the account balance as of the prior December 31 divided by a number that is one less than the previous year’s divisor.

Five Year Rule

If the Five Year Rule applies, every penny of the account must be withdrawn by the December 31 following the 5th anniversary of the owner/participant’s death. Withdrawals can be made at any time in the period so long as the account is emptied by that date.

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