Our disciplined friend asks us: what if at the end of my days there was a remnant left in my retirement accounts?
Let us first clarify that it is difficult to achieve a financial plan that is both robust (in terms of meeting long-term financial needs under multiple scenarios), and that makes the end of life coincide with the depletion of retirement accounts. This scenario, although ideal, is unlikely, being the most usual to have money left. In other words, to prepare for possible negative scenarios it is necessary to accumulate more, and therefore there is usually a remaining balance in the rest of the scenarios.
The trivial answer to our friend’s question would be “those you have designated as beneficiaries will receive the remaining wealth[1].” However, recently enacted laws and rules[2] have changed previous standards, added complexity, and which we will do our best to summarize[3] below.
The new laws state that only designated beneficiaries who have been spouses have the best planning options. If they act within the pre-established times, the beneficiary spouses will be able to choose the most convenient options for their circumstances and needs, either by assuming the remaining assets in their own account or in an inherited account, or by choosing the rule that establishes the cadence and amount of the withdrawals. The rules differentiate whether the original owner (in this case, a spouse) died before or after the starting date of RMDs[4]. In general, if the spouse died after the start of RMDs, distributions would continue unless the beneficiary spouse transfers the account to one of his or her own. If the original owner had not reached the start of RMDs, the surviving spouse could delay the start of RMDs. Using own accounts favors a strategy of delaying withdrawals, while using Inherited IRAs favor immediate withdrawals, regardless of the age of the beneficiary. In both cases, there is no obligation to withdraw assets in a predetermined number of years, which is a great benefit.
Designated beneficiaries who have not been spouses have less flexibility and planning options. For them, the options are twofold: if the original owner died after RMD, the beneficiary must continue the RMD according to their life expectancy or that of the original owner and have withdrawn all assets after 10 years. If the original owner died prior to RMD, the beneficiary must take everything by the end of year 10, without being subject to RMD. This type of beneficiary does not have the option to transfer the assets to their own account, only to an inherited account.
There is a subgroup within designated beneficiaries who have not been spouses that has a separate set of rules. This subgroup consists of the minor children of the original owner, disabled and chronically ill beneficiaries (as defined by the IRS), and beneficiaries who, being younger than the original owner at the time of their death, the age difference is less than 10 years. For this subgroup, if the original owner has died after RMD, the withdrawals (RMD) must continue but using the life expectancy of the original owner or their own. If the original owner had not reached RMD, these beneficiaries will be able to use the 10-year rule or use their own life expectancy. Minor children must have withdrawn everything before they turn 31 (i.e., the 10-year rule applies to them from the age of 21). This subgroup also does not have the option of transferring assets to their own account, only to an inherited account.
Finally, we refer to non-designated beneficiaries, that is, beneficiaries who are not natural persons[5]. In this case, if the original owner had reached RMD, the withdrawals would follow the life expectancy of the original owner. If the original owner has not reached RMD, beneficiaries must remove everything before the fifth year after death.
In the case of Roth accounts, although RMDs do not apply to the original owners, beneficiaries will have to make periodic withdrawals based on their life expectancy or timebound (10-year rule). Specifically, spouse beneficiaries will be able to transfer the assets to their own Roth account, without restrictions, or to an inherited account with periodic withdrawals based on their own life expectancy. Non-spouse beneficiaries must make the full withdrawal before the tenth year, and beneficiaries who belong to the subgroup will be able to choose between adhering to the 10-year rule or taking RMD according to their life expectancy. As in the previous case, minor children must withdraw everything before age 31.
Employer-led plans (401k) follow similar rules, but their charters may limit the options listed above. In this case, it is important to consult the rules of the specific plan.
Unfortunately, there are also time limits to make the selections and beneficiaries will have to act expeditiously to make their choices. Letting time pass can work against them.
When establishing a financial plan, it is important to consider both the appointment of the beneficiaries and the possible impact on their financial planning. Distribution rules are a complex issue that requires qualified advice.
Notice: The information provided herein is for educational purposes only. Portfolio Resources Group does not guarantee the accuracy of any tax recommendation, as we do not provide tax or legal advice. Consult a tax professional to ensure that the recommendations are appropriate for your situation.
[1] In a previous article (“Designated Beneficiaries”) we developed the importance of doing so and its advantages. A designated beneficiary is a natural person established as such in the account documents.
[2] We refer to the SECURE Act 1.0 (2020) and SECURE Act 2.0 (2022) as well as the subsequent revisions to rules and procedures.
[3] The scope of this article does not allow us to review each of the possible cases. The IRS guide (590-B) is about forty pages long and details each case. We suggest seeking help from a qualified financial advisor or a tax attorney or accountant.
[4] RMDs (required minimum distributions) are a requirement of the IRS to start taxing capital that has been accumulating and growing without paying taxes. RMDs are based on life expectancy. This concept does not apply to Roth account owners.
[5] There are exceptions to this rule that we are not going to cover in this article.