Individual Retirement Accounts and Trust Beneficiaries | Wolters Kluwer
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    DianaTheis Onward

    by Diana Theis, Consultant, Tax Advantaged Accounts, Wolters Kluwer

    Published April 03, 2019



    Overview

    Individual retirement account (IRA) rules define the options available to a beneficiary of an IRA after an IRA owner’s death. Unless a beneficiary takes a lump sum death distribution, or a surviving spouse treats a decedent’s IRA as his/her own IRA, the beneficiary must generally take distributions using the single life expectancy payout method or, if available, elect (or default to) the five-year rule. A beneficiary’s relationship to the deceased IRA owner (i.e., a surviving spouse, nonspouse, or nonindividual), and with respect to a traditional IRA, whether an IRA owner passed away prior to his/her required beginning date (RBD) or on/after his/her RBD (i.e., April 1 of the year after attainment of age 70½), determine which payout method (i.e., single life expectancy or the five-year rule), is available to the beneficiary.

    This article explains the payout methods available to trust beneficiaries. However, before we get into the specific rules applicable to trusts, let’s first review the five-year rule and single life expectancy payout methods in general.

    Five-Year Rule

    The five-year rule is only available when a traditional IRA owner passes away prior to his/her RBD. This option is always available to a Roth IRA beneficiary. The five-year rule requires that all assets be distributed from an inherited IRA by December 31 of the fifth year after an IRA owner’s death year. Distributions can be taken periodically or sporadically during the five-year period, which includes taking a lump sum distribution of the IRA balance at any time.

    Single Life Expectancy

    The single life expectancy payout method requires that a beneficiary take an annual RMD based generally on his/her life expectancy, assuming that in a case with multiple beneficiaries each beneficiary’s inherited share is accounted for separately.

    Qualified Trust as IRA Beneficiary

    If a qualified trust is the beneficiary of an IRA, the single life expectancy divisor of the oldest trust beneficiary, determined the year after an IRA owner’s death, is used to calculate the annual RMD. If a spouse is the sole beneficiary of the qualified trust, the single life expectancy divisor could be determined as late as the year the decedent would have attained age 70½ to calculate the annual RMD.

    For RMD purposes, a trust is qualified if it meets the following requirements:

    • It is a valid trust under state law,
    • It is irrevocable or becomes irrevocable upon the IRA owner’s death,
    • The beneficiaries of the trust are identifiable as individuals, and
    • The trustee of the trust provides a copy of the trust document or a certified list of the beneficiaries to the IRA custodian/trustee by October 31 of the year following the year of the IRA owner’s death.

    Though it is not an IRA custodian/trustee’s responsibility to determine whether a trust is qualified, each financial organization should have a policy as it relates to assisting a trustee in determining the payout method(s) available to a trust beneficiary. The trustee of a trust is responsible for providing the custodian/trustee with the required information. If the single life expectancy payout method is used, the trustee of the trust is responsible for calculating and taking the RMDs. If the trust requirements above were not met or a trustee does not provide beneficiary information prior to the October 31 deadline, the trust will be treated as a nonqualified trust, and likely reducing the amount of time for the trust to liquidate the IRA.

    IRA Owner’s Death Prior to RBD

    When an IRA owner passes away prior to his/her RBD, or the IRA is a Roth IRA, a qualified trust beneficiary can take the remaining balance of the decedent’s IRA using either the five-year rule or single life expectancy payout method. The divisor used to calculate distributions under the single life expectancy method is obtained from the Single Life Expectancy Table and is based on the oldest trust beneficiary’s age the year after the IRA owner’s death. The divisor is reduced by one each subsequent year (i.e., the reduction method). If the IRA owner’s spouse is the sole beneficiary of a qualified trust, the surviving spouse’s attained age is used each year to determine the divisor (i.e., the attained age method), and distributions must begin by the later of the year following the IRA owner’s death or the year the IRA owner would have attained age 70½.

    Example—Nonspouse or Multiple Beneficiaries in Qualified Trust

    Katelyn died in 2018 at age 67. The beneficiary of her IRA is a qualified trust. The beneficiaries of the trust are her two children, Eleanor, age 36 and Isaac, age 32 at the end of 2018. The trustee can choose between the five-year rule and single life expectancy options for RMD purposes. If the trustee chooses single life expectancy, the distribution period (i.e., 46.5) is determined by looking at Eleanor’s age (i.e., 37) the year after Katelyn’s death (i.e., 2019). The divisor used to calculate distributions is reduced by one each subsequent year.

    Example—Spouse is Sole Beneficiary of Qualified Trust

    Fred died in 2018 at age 55. The beneficiary of his IRA is a qualified trust. The sole beneficiary of the trust is his spouse, Marge, age 52. The trustee can choose between the five-year rule and single life expectancy payout method. If the trustee chooses single life expectancy, the RMD is calculated using Marge’s attained age each year, and no minimum distributions are required until the year Fred would have attained age 70½, rather than starting the year after death.

    When an IRA owner passes away prior to his/her RBD (or the IRA is a Roth IRA) and the beneficiary of his/her IRA is a nonqualified trust, the trust’s only available RMD option is the five-year rule.

    IRA Owner’s Death On or After RBD

    When an IRA owner’s death occurs on or after his/her RBD, a qualified trust beneficiary uses the longer of the decedent’s single life expectancy, determined the year he/she passed away and reduced by one each year (i.e., the reduction method), or the oldest trust beneficiary’s single life expectancy, using the reduction method, to determine the RMD amount each year. If an IRA owner’s spouse is the sole beneficiary of a qualified trust and younger than the decedent, the surviving spouse’s attained age method is used to calculate the RMD amount each year. The five-year rule is not available when death occurs after the RBD.

    When an IRA owner passes away after his/her RBD and the beneficiary of his/her IRA is a nonqualified trust, distributions are calculated using the deceased IRA owner’s life expectancy, determined the year he/she passed away and then using the reduction method for subsequent years to calculate the RMD amount.

    Example—Death On/After RBD—Nonqualified Trust Beneficiary

    Vernon, who would have been 78 years old at the end of 2018, passed away in 2018. RMDs to the beneficiary of Vernon’s IRA, a nonqualified trust, are determined using the single life expectancy payout method beginning the year after Vernon’s death. The divisor used to calculate the 2019 RMD is determined by taking the divisor based on Vernon’s age 78 in 2018 (i.e., 11.4) and reducing it by one (i.e., 10.4). RMD amounts for subsequent years are determined by continuing to reduce the divisor by one each year (i.e., 9.4 in 2020, 8.4 in 2021, etc.).

    Spouse as Sole Qualified Trust Beneficiary

    A spouse who is the only beneficiary of a qualified trust that is the beneficiary of an IRA cannot treat the IRA as his/her own IRA. However, private letter rulings (PLRs) have allowed a spouse who is the only beneficiary of a trust, and its trustee, to roll over assets to an IRA of his/her own after a death distribution had been paid to the trust. A PLR does not set legal precedent and can only be relied on by its requester.

    Payout Methods Available to a Trust Beneficiary

     

    Nonqualified Trust

    Qualified Trust

    Traditional IRA

    Death Before RBD: Five-Year Rule

    Death on/after RBD: Single Life Expectancy

    Death before RBD: Five-Year Rule, or Single Life Expectancy of Trust Beneficiary

    Death on/after RBD: Single Life Expectancy

    Roth IRA

    Five-Year Rule

    Five-Year Rule, or

    Single Life Expectancy of Trust Beneficiary


    Reporting

    Revenue Procedure 89-52 sets forth the annual reporting requirements for a deceased IRA owner and any beneficiaries after an IRA owner’s death. An IRA custodian/trustee must report applicable information indicating the IRA’s beneficiary status and using the proper tax identification number.

    Example—Trust Beneficiary

    Continuing with a previous example, Katelyn died in 2018 leaving her IRA to her qualified trust. The IRA custodian/trustee must obtain the tax identification for the trust from the trustee. To comply with the IRS reporting instructions for the Form 5498, the beneficiary IRA is titled accordingly:

    “Katelyn’s Family Trust as Beneficiary of Katelyn’s Traditional IRA” or something similar.

    Although a trust will have one or more beneficiaries, annual IRS Form 5498 and 1099-R reporting is generally completed in the name and tax identification number of the trust.

    Conclusion

    Administrating an IRA after an IRA owner’s death can pose challenges if you are not aware of the reporting requirements or exactly how your financial organization’s administration system works. Additional complexity generally results when a trust is named as beneficiary. If a trustee of the trust chooses to not take a lump sum distribution from the IRA, it might be necessary for the IRA custodian/trustee to know whether the trust is a qualified or nonqualified trust. The trustee of a qualified or nonqualified trust is responsible for calculating RMD amounts as well as ensuring the RMD is taken timely. Additionally, for a trust to be considered qualified, providing the IRA custodian/trustee the proper certification of the beneficiaries of the trust or a copy of the trust is essential. Professional tax or legal guidance is advised if there are any issues regarding the trust.

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