What Is It?
The life expectancy method is a method of taking distributions from an inherited IRA or employer-sponsored retirement plan account. As the name suggests, it allows you to take post-death distributions based on your life expectancy. Under this method, you must receive a certain minimum amount each year. You can always take larger distributions than required, but if you withdraw less than required in any year, a 50 percent federal penalty tax will apply to the undistributed required amount. The annual required distributions are calculated to dispose of the entire balance in the inherited IRA or plan over your remaining life expectancy. The applicable life expectancy is determined according to IRS life expectancy tables.
The main advantage of the life expectancy method is that it typically allows distributions to be taken over a period of many years. In fact, in many cases, this method will result in the longest possible payout period for post-death distributions. As discussed below, a longer payout period can provide significant income tax advantages. Obviously, younger beneficiaries will benefit the most from the life expectancy method because their post-death payout periods will reflect their longer life expectancies.
Caution: If an IRA owner or plan participant dies after his or her required beginning date, and there is no designated beneficiary, distributions are generally based on the owner's or participant's remaining life expectancy (calculated in the year of death).
Note: For IRA owners and plan participants dying after December 31, 2019, distributions to a designated beneficiary must be made by the end of a 10-year period unless the designated beneficiary is an eligible designated beneficiary. An eligible designated beneficiary is a designated beneficiary who is the surviving spouse of the employee or IRA owner, a minor child of the employee or IRA owner, disabled, a chronically ill individual, or an individual who is no more than 10 years younger than the employee or IRA owner. There are special rules for certain trusts for disabled or chronically ill beneficiaries.
Note: Required minimum distributions are waived for defined contribution plans (other than 457 plans for nongovernmental tax-exempt organizations) and individual retirement accounts for 2020.
The IRS Distribution Rules
Under IRS regulations, the life expectancy method is generally the default payout method for inherited IRAs and employer-sponsored retirement plans, regardless of when the account owner died, if the account has a designated beneficiary (as defined below) and the IRA owner or plan participant died before 2020. If the IRA owner or plan participant dies after 2019, the life expectancy method will not be available unless the designated beneficiary is an eligible designated beneficiary. If there is no designated beneficiary and the owner dies before his or her required beginning date for required minimum distributions, then the five-year rule, not the life expectancy method, is used.
For the life expectancy method to be used, the distributions generally must begin no later than December 31 of the year following the year in which the IRA owner or plan participant died. If the distributions do not begin on or before this December 31 date, the life expectancy method can no longer be used.
As mentioned, post-death distributions taken under the life expectancy method may be based on the beneficiary's remaining life expectancy. However, if the IRA owner or plan participant dies on or after his or her required beginning date (generally the April 1 following the year in which he or she reaches age 70½ (age 72 if attain age 70½ after 2019)), distributions may be taken over the longer of (1) the designated beneficiary's single life expectancy, or (2) the deceased IRA owner's or plan participant's remaining single life expectancy. If the beneficiary's life expectancy is shorter than that of the deceased (according to IRS tables), the second option is desirable because it allows distributions to be taken over more years. This could be the case, for example, if the beneficiary is a parent or older sibling of the deceased.
Caution: With an inherited retirement plan account, the plan is generally allowed to specify the post-death distribution options available. These options may or may not be the same as the options permitted under IRS distribution rules. For example, if the plan participant died before his or her required beginning date, the plan may require that the five-year rule (or the 10-year rule) be the default payout method, and you may or may not be able to elect an alternate payout method. However, you may be able to make a tax-free rollover of your inherited retirement plan account to an IRA with more flexible distribution provisions.
Caution: Roth IRA owners are not subject to the required minimum distribution rules during their lifetimes. However, inherited Roth IRAs are subject to the post-death required distribution rules described in this article. Because Roth IRA owners do not have a "required beginning date," the post-death required minimum distribution rules are always applied as if the Roth IRA died before his or her required beginning date.
Tip: If the life expectancy method is used, there is one situation in which the distributions may begin later than described above. If the IRA owner or plan participant dies before the required beginning date, and his or her surviving spouse is the sole designated beneficiary, the distributions may begin as late as the year that the owner or participant would have reached age 70½ (age 72 if attain age 70½ after 2019), (if later than December 31 of the year following the year of death). Caution: If an IRA owner or plan participant dies after his or her required beginning date, and there is no designated beneficiary, distributions are generally based on the owner's or participant's remaining life expectancy (calculated in the year of death).
Only Designated Beneficiaries Can Use This Method
Note: For IRA owners and plan participants dying after December 31, 2019, only eligible designated beneficiaries can use the life expectancy method. An eligible designated beneficiary is a designated beneficiary who is the surviving spouse of the employee or IRA owner, a minor child of the employee or IRA owner, disabled, a chronically ill individual, or an individual who is no more than 10 years younger than the employee or IRA owner.
For the life expectancy method to be available as a post-death option, the IRA or plan account must have one or more designated beneficiaries as of the September 30 next-year date (September 30 of the year following the year of the IRA owner's or plan participant's death). A designated beneficiary is an individual who is named by you, or specified in the IRA or plan documents, as a beneficiary. It could be a spouse, a child, a grandchild, a parent or other relative, a friend, or any other individual. Any of these individuals has a life expectancy that can be used to measure the post-death payout period for purposes of the life expectancy method.
Obviously, if there are no beneficiaries named on the IRA or plan account, there is no designated beneficiary. In this case, the decedent's estate becomes the default beneficiary, and post-death distributions generally must be made either according to the five-year rule (if death occurred prior to the required beginning date) or over the decedent's remaining life expectancy (if death occurred after the required beginning date). The same limited options apply if there are any nonindividual beneficiaries named on the IRA or plan account, such as the decedent's estate or one or more charities. (Special rules apply if a trust is named as beneficiary.) These types of beneficiaries are not designated beneficiaries and cannot use the life expectancy method.
Caution: If, as of the September 30 next-year date, both individuals and nonindividuals are named as beneficiaries of the IRA or plan account (for example, your child and a charity are each to receive 50 percent), then even the individual beneficiaries (your child in the example) will not be able to use the life expectancy method. One way to avoid this result is to have the nonindividual beneficiary's interest in the account paid out by the September 30 date.
What If There Are Multiple Designated Beneficiaries?
It is not uncommon for a single IRA or plan account to have more than one individual designated as a primary beneficiary. The beneficiary designation form for the account will typically list all of the primary beneficiaries by name, as well as the portion of the funds that each beneficiary is to receive. Fractional or percentage amounts usually make more sense, since the dollar value of the account usually fluctuates with the underlying investments and the separate accounts rules generally won't apply to pecuniary (specific dollar amount) bequests. Further, depending on the IRA owner's or plan participant's instructions, the account may not be divided equally among the primary beneficiaries.
If the IRA or plan account has multiple designated beneficiaries as of the September 30 next-year date, the life expectancy method can still be used to take post-death distributions, but special rules apply. The new distribution rules require that in this situation, the age of the oldest designated beneficiary (i.e., the one with the shortest life expectancy) be used for purposes of calculating post-death distributions. This is a potential drawback because the other, younger primary beneficiaries would then be subject to a shorter payout period than they might otherwise have been. For example, if a 45-year-old man and his 30-year-old sister are equal beneficiaries of their deceased father's IRA, the sister's annual distributions would have to be based on her brother's life expectancy.
However, there is a way to avoid this outcome. The final distribution rules provide that if an IRA or plan account has multiple primary beneficiaries, the account may be split into separate accounts. This can generally be done at any time up until December 31 of the year following the year of the IRA owner's or plan participant's death (but note that designated beneficiaries are determined by September 30 of the year following the participant's death--it may be more prudent to establish separate accounts by September 30 to avoid any problems with the inconsistency of the September 30 and December 31 dates). Each account and its beneficiary would then be treated separately for purposes of calculating required post-death distributions. This can allow a younger beneficiary to take post-death distributions over his or her own single life expectancy, providing a longer payout period than would otherwise be available.
Caution: The rules regarding separate accounts are complex. Consult a tax professional for guidance.
Advantages of the Life Expectancy Method
May Provide the Longest Payout Period
The life expectancy method generally allows post-death distributions to be taken over a period of years. The actual length of the post-death payout period will depend on your remaining single life expectancy, according to IRS life expectancy tables. Younger beneficiaries obviously have longer life expectancies and will therefore enjoy a longer payout period under the life expectancy method. In effect, if you are a relatively young beneficiary of an IRA or plan account, you may be able to withdraw the inherited funds over a period of many years. In this case, the life expectancy method will usually be your best choice for taking post-death distributions. Even if you are an older beneficiary, this method may provide a longer payout period than other post-death options.
There are two important reasons why it is in your best interest as an IRA or plan beneficiary to have the longest possible payout period. First, it maximizes the growth potential of the funds. The longer funds remain in an IRA or plan, the longer the investment earnings can grow tax deferred. The other advantage of a long payout period is that it spreads out your income tax liability on the inherited funds. You are able to pay less income tax each year, since the annual distribution amounts are smaller than they might otherwise be. With a shorter payout period, the larger distributions increase your taxable income each year, possibly even pushing you into a higher income tax bracket.
Tip: If you are a surviving spouse beneficiary of an IRA or plan account, you can generally use the life expectancy method like any other designated beneficiary, but this is typically not your only post-death option. Depending on your age and other factors, choosing one of your other options will often be more beneficial to you than using the life expectancy method.
You Will Receive An Income Stream And Have Some Flexibility
If you are an IRA or plan beneficiary, one potential advantage of using the life expectancy method for post-death distributions is that you will enjoy a steady stream of income. That is because under this method, you will generally be required to take a distribution from the IRA or plan account every year for the rest of your life. (The amount of each required distribution will depend on your life expectancy and the account balance.) You may consider this a drawback if you want to minimize your taxable income, especially if you are already in a high income tax bracket. However, if you need additional income, the predictability of receiving annual IRA or plan distributions may appeal to you. You can use the money to meet your ongoing expenses, fund a large purchase, or invest elsewhere.
In addition to controlling how the funds are to be used, you have some control over the size of your distributions. Although you cannot withdraw less than the minimum required amount in any year (at least not without being penalized), you are not limited to withdrawing only that amount. You can always take a larger distribution than required in any year, including a lump-sum distribution of the entire account balance. This gives you some flexibility to tailor your distributions to your changing needs and circumstances.
Disadvantages of the Life Expectancy Method
If you are an IRA or plan beneficiary, there are no clear disadvantages to using the life expectancy method for post-death distributions. You will have to pay federal (and possibly state) income tax on all or part of each distribution you receive, but this will generally be the case with any post-death payout method that you select. However, if you are a surviving spouse, you have options that may provide superior planning opportunities.
How to Do It
- Contact the IRA trustee or the plan administrator: If an IRA owner or plan participant has died and you are one of the account beneficiaries, your first step should be to contact the IRA custodian or plan administrator. Find out whether the life expectancy method is an option for you. Get professional advice as to whether it is a good idea to choose this payout method. Assuming that the life expectancy method is available and appropriate for you, find out what you need to do to elect this payout method. You will typically have to complete a distribution form and provide certain documentation (such as identification and a birth certificate).
- Determine how much you must withdraw: To avoid the federal penalty tax, make sure you know how much you must receive from the IRA or plan account under the life expectancy method. You calculate your minimum required distribution for any year by dividing the account balance (generally, as of the end of the prior year) by your applicable life expectancy. To determine your applicable life expectancy, you will need to refer to the IRS life expectancy tables. To avoid potentially costly mistakes, you may want to have a tax advisor assist you with this process.
- Include the appropriate amount in your taxable income: For every year that you receive a distribution from the IRA or plan account, determine the taxable portion of the distribution and enter that amount on your federal income tax return. In addition to federal income tax, state income tax may apply, so check your state's tax laws.
This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.
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