In last week’s blog post I went over what happens to your retirement account when you die. This week I want to discuss how the funds in your IRA or 401(k) (or 403(b)) may be distributed after you die.
As discussed last week (click here for last week’s article) if you die leaving funds in an IRA or 401(k) the person or persons listed as your beneficiary with the financial institution or plan administrator will be entitled to those funds. Also as discussed, how those funds are paid out will have tax consequences.
How Retirement Funds Are Paid Out to Your Beneficiaries
So, how are retirement funds paid out to your beneficiaries after you die? Pay out options depend on a few things including your age at death, who the beneficiary is, and rules and requirements of the financial institution or administrator of the IRA, 401(k) or 403(b). Under federal law, someone must begin withdrawing funds from their IRA or 401(k) when they reach 70½ years of age. This is known as required minimum distributions (or RMD for short).
A Single Beneficiary
If you die before reaching age 70½ and your beneficiary is one person, the beneficiary must begin withdrawing from the account in the year following your death (different rule apply for a surviving spouse). The beneficiary can withdraw any amount from the account, but must withdraw at least the annual required minimum. Again, it is usually beneficial for taxes if withdrawals are made over a period of years. The required minimum withdrawal each year is determined based on the beneficiary’s life expectancy as defined by the IRS (life expectancy tables can found here about 2/3 of the way down the page).
Warning: even though the IRS will let an individual beneficiary make withdrawals stretched out over their lifetime, some IRAs or 401(k) plans require that the funds be withdrawn much sooner. Check with the plan administrator or financial institution the 401(k) or IRA is with to find out when funds have to be withdrawn. If the plan requires a quick withdrawal, you may be able to transfer the funds to an account or plan with a more favorable distribution scheme.
If you die before reaching age 70½ and have named multiple beneficiaries on your IRA or 401(k), then the minimum required withdrawals are determined based on the life expectancy of the oldest beneficiary. However, the beneficiaries may divide the funds into separate accounts for each beneficiary and if they do, then the life expectancy for each beneficiary is used determine the minimum withdrawals.
Trust as Beneficiary
If you die before reaching age 70½ and have named a trust as your beneficiary on your IRA or 401(k) then the trust must qualify as a Designated Beneficiary under federal law. If the trust is a Designated Beneficiary, then the withdrawal minimums will be based on the life expectancy of the oldest beneficiary named in the trust document. Tip: if you plan on listing your trust as your beneficiary on your retirement accounts, consider the ages of the trust beneficiaries.
If you die before reaching age 70½ and you list a non-qualifying trust as beneficiary or if you list no beneficiary (or your named beneficiary dies before you) then those receiving your IRA or 401(k) funds must withdraw all of the funds within five years from the date of your death.
Death After Age 70½
All of the above sets out what happens if you die before reaching age 70½. What happens if you die later than that? If you die after the RMD date, withdraws from your IRA or 401(k) can either be based on the beneficiary’s life expectancy or your life expectancy, whichever is longer. If the retirement account has no beneficiary, then the withdrawal period is based on your life expectancy.
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