The beneficiary spouse’s choice of an IRA will affect the rate at which distributions must be withdrawn and the income tax payable. And with the new restrictions explained in the Proposed Minimum Required Distribution Regulations for Secure Act 1.0, the timing of elections is now added to the list of considerations for the decision-making process. Sometimes the decision must be made before the beneficiary spouse accepts ownership of the IRA.
The Secure Act, signed into law on December 20, 2019, changed the distribution options for beneficiaries of IRAs and employer plans. Under these changes, the beneficiary spouse is among the few eligible to withdraw RMDs from inherited accounts during their lifetime. But only the beneficiary spouse can transfer the inherited IRAs to their own or employer IRA account.
The Treasury Department and the IRS issued draft RMD regulations on February 24, 2022 (87 FR 10504), which explains that a new time limit now applies to when a beneficiary spouse can elect to treat an inherited IRA as his. These proposed RMD regulations also limit the ability of a beneficiary spouse to use the five-year rule or the 10-year rule and then switch to their own IRA to avoid taking life expectancy distributions from the beneficiary. But even with this new limitation, the beneficiary spouse still has three options:
- IRA beneficiary
- Treat as if it were
- ride on their own
An IRA beneficiary’s RMDs are calculated using the unique life expectancy table, using only the beneficiary spouse’s age or, in cases where the owner died on/after the required start date, or RBD, the longer of the life expectancy of the deceased or beneficiary spouse.
For the spouse’s own IRA, RMDs are calculated using the Uniform Lifetime table, based on the age of the beneficiary spouse and a beneficiary assumed to be 10 years younger than them.
The single life expectancy table produces significantly higher RMDs than the RMDs calculated using the Uniform Lifetime table.
The beneficiary IRA option
The beneficiary spouse who chooses the beneficiary IRA option would be transfer the amount to an IRA registered in the name of the deceased and the surviving spouse: for example, Sharon Smith as Mark Smith Beneficiary. Beneficiary IRA is also known as inherited IRA in the IRA industry.
The IRA custodian must enter Code 4-Death in box 7 of Form 1099-R. Code 4 informs the IRS that the distribution is exempt from the additional 10% tax on distributions made before age 59½ (“early” distributions). This automatic qualification for the additional 10% tax exemption is one of the reasons the beneficiary IRA option should be chosen for a beneficiary spouse under age 59.5. This benefit is lost if the beneficiary spouse moves the inherited IRA to their own IRA.
The beneficiary spouse who keeps the assets in a beneficiary IRA must take annual RMDs on their life expectancy if the 10-year rule (five years if the owner died before 2020) does not apply. These annual RMDs must begin no later than December 31 of the year following the year of the IRA owner’s death or the year in which the IRA owner should have started taking RMDs. he had lived, according to the latest date. The RMD life expectancy for the beneficiary is calculated using the unique life expectancy table.
The five-year or 10-year rule applies depending on the terms of the IRA agreement or beneficiary spouse’s choice if the IRA owner dies before their RBD. Under the 10-year rule, distributions are optional (no RMD) until the 10th year after the death of the owner, when the balance must be distributed. The five-year rule is similar, except the final year is the fifth year.
The Treat as if option
A beneficiary spouse can choose to treat an inherited IRA as their own if they are the sole beneficiary and have unlimited rights to withdraw amounts from the IRA.
The choice to process an inherited IRA is made by the surviving spouse who redesignates the inherited IRA in their name. The name of the deceased is not included in the record.
Failure to take RMDs from beneficiaries within the required timeframe and/or make a regular IRA contribution or a 60-day rollover contribution to the legacy IRA would result in the “treat as if” election. However, I am not aware of any IRA custodian that allows regular IRA contributions to be made to inherited IRAs.
The code in box 7 of IRS Form 1099-R is determined by age and whether the beneficiary spouse qualifies for certain exceptions to additional tax on early distributions. Code 1-Early release, no exceptions known is used if the beneficiary spouse is under age 59.5 and the distribution is not made in one of the following circumstances:
- Due to an IRS levy
- While the IRA owner is deactivated
- For conversion directly to Roth IRA
- Under a program of substantially equal periodic payments
Otherwise, Code 2-Early distribution, an exception applies would be used, except in case of disability, where Code 3-Disabilitywould be used.
Code 7-Normal Distribution is used once the IRA owner reaches age 59½ and is therefore generally exempt from the additional 10% tax on early distributions.
The beneficiary spouse is treated as the owner (not the holder of an inherited IRA) beginning on January 1 of the year the election was made to treat the inherited IRA as their own, meaning they is allowed to make regular IRA contributions, perform Roth IRA conversions, and perform rollovers and transfers under owner (non-beneficiary) rules.
RMDs for the spouse’s own IRA would be calculated using the Uniform Lifetime table.
New deadline for treating as if you were the owner
We can no longer tell beneficiary spouses that they have always and one day to choose the treatment option as if they were their own for inherited IRAs. Instead, the proposed RMD regulations for Secure Act 1.0 explain that the deadline for a beneficiary spouse to treat an inherited IRA as their own is the later of the following dates:
- The end of the calendar year in which the surviving spouse reaches the applicable RMD age, and
- The end of the calendar year following the calendar year in which the owner of the IRA dies.
If a beneficiary spouse misses the deadline to treat an inherited IRA as their own, there’s still hope because they can carry forward the amount instead. But any beneficiary RMD due must be withdrawn before the rollover.
The rolling option
A beneficiary spouse can transfer an inherited IRA to their own IRA.
However, this rollover may not include RMDs. The proposed RMD rule explains that a beneficiary spouse who elects the five-year or 10-year rule and later decides to transfer the beneficiary IRA to their own is subject to a hypothetical RMD. This hypothetical RMD applies if the deferred amount is distributed before the fifth or 10th year of the five or 10 year period and during or after the year in which the beneficiary spouse reaches the age at which RMDs must begin from their own IRA.
This hypothetical RMD is the RMD that would have applied for years up to the year of the rollover if the beneficiary spouse had elected to receive distributions on their life expectancy instead of the five or 10 year rule – and it is reduced by any distributions taken by the beneficiary spouse during those years.
The 1099-R reporting requirements are the same as those that apply to the treat-as-own option once the assets have been transferred.
After rollover, RMDs would be calculated using the Uniform Lifetime table.
Note: A beneficiary spouse can also carry over eligible amounts to their own account under an employer-qualified plan, 403(b), or a government 457(b) plan.
Choose the right option
A beneficiary spouse who chooses the beneficiary IRA option can transfer the assets to their own IRA later. But once the assets are transferred to the beneficiary spouse’s own IRA, there is no turning back. Therefore, the beneficiary IRA option should be chosen when there is uncertainty as to the best option. The assets can then be transferred to the beneficiary spouse’s IRA when tax-efficient.
Ultimately, which option is right for a beneficiary spouse depends on their beneficiary profile, including whether to avoid the additional 10% tax and/or minimize distributions.