Planning for an inheritance to be passed on to your loved ones with minimal complications means making sure some key details are in place.
Among them might be identifying an Eligible Designated Beneficiary (EDB) for your retirement accounts like your IRA. They will be the official individual to inherit your assets after your death. This person not only inherits your retirement funds, but has more flexibility in how they get access to them compared to typical beneficiaries. That’s because EDBs get special treatment for how they can withdraw from the retirement accounts they inherit.
Who Can Qualify as an Eligible Designated Beneficiary?
Rules have recently changed a bit regarding how retirement account inheritances are treated. The Setting Every Community Up for Retirement Enhancement (SECURE) Act, which went into effect Jan. 1, 2020, establishes the criteria for being an Eligible Designated Beneficiary, among other retirement-related rules. It requires that funds in an IRA (including SEP IRAs and SIMPLE IRAs) of a person who dies must be distributed within 10 years. This is also known as the “10-year rule.”
The exception to that is the 5 types of EDBs we’ll review below – a spouse, child, a terminally ill or disabled individual, or an individual no less than 10 years younger than the original account holder. These individuals often have longer to withdraw the funds, so they can more easily withdraw in a way that benefits their own financial situation. In most cases, an EDB may withdraw their inherited funds over the course of their life expectancy.
The first thing to know is that an EDB must be a person – it can’t be an entity like an estate, or a trust or a nonprofit organization or charity, as Investopedia explains in “Eligible Designated Beneficiary.”
As a side note, the SECURE Act didn’t change the rules for nonindividual beneficiaries. In those cases, the beneficiary must withdraw the assets within five years if the owner of the IRA dies before their required beginning date (or if they hold a Roth IRA). If the account owner dies after the required beginning date, then the beneficiary can maintain the distributions using their single-life expectancy.
A surviving spouse has a couple of ways to receive funds from an inherited IRA as an Eligible Designated Beneficiary. First, the spouse can simply withdraw funds from the IRA as the original owner would – over the course of their life expectancy.
Secondly, they can rollover the funds into their own IRA and then make withdrawals from their account as they normally would, but with the additional funds included. So, in that case, they would have to abide by any required minimum distributions (RMDs). (The SECURE Act also changed the rules for RMDs, raising the age you must take a distribution to 72.)
Owner’s Child Under Age 18
Children who are under 18 can withdraw funds from an inherited IRA. When they turn 18, they then have 10 years to withdraw all the funds from the account.
If the original account owner’s child is going to college, they may delay starting the 10-year rule until they’re 26 with an extension.
A Disabled Individual
If a disabled person inherits a retirement account, they can calculate RMDs based on their own life expectancy.
The person must meet the criteria for being disabled as defined by the IRS, which in part states that a person with a disability is one who is “unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration.”
A Terminally Ill Individual
Similarly, a terminally ill person can calculate RMDs based on their own life expectancy if they inherit a retirement account. They must meet the IRS criteria for being terminally ill, which includes being diagnosed by a licensed healthcare professional. To be considered a terminally ill EDB, you might:
- Be unable to perform at least 2 daily living activities for at least 90 days.
- Require substantial supervision for protection against threats to your health and safety.
Person Less Than 10 Years Younger
Finally, people who are the EDBs who are less than 10 years younger than the account holder, such as a sibling or friend, can also use their own life expectancy to calculate RMDs from an inherited retirement account. So, that would not include the children of the retirement account owner.
Do You Need a Will if You Have an Eligible Designated Beneficiary?
In many cases designating a beneficiary may be enough to transition your assets smoothly. However, sometimes complications can arise with distributing assets after death with only beneficiaries named to accounts. For example, the deceased person may have debt obligations or want to allocate funds toward funeral expenses.
A professional financial advisor can walk you through how to best manage your own assets to put them on the right inheritance track in a way that meets your goals.
The Bottom Line
Taking time to set up a plan for the transfer of your retirement accounts will go a long way in saving your loved one’s time and money. By establishing an Eligible Designated Beneficiary, you can ensure your hard-earned retirement account money will go to the right person and will give them the best access to their inheritance.
For more help addressing your retirement account designees, you can turn to a professional financial advisor. They can review your personal situation and guide you through the retirement planning and estate planning processes with specific suggestions for your situation. After all, the “right” way to make withdrawals will depend on a number of factors, from your tax bracket to your age.
Here’s to the Wellness of Your Wallet!