September 30 Deadline Key to Beneficiary Distributions
by Robert Shipp, QKA, CIP, CHSP, CIS
As the end of September approaches, so does the deadline for determining the designated beneficiaries of an IRA or employer-sponsored retirement plan. Understanding the reason for this deadline and how it applies to beneficiary distributions is crucial when handling payments to beneficiaries so as not to wrongly pay out these accounts after an IRA owner or plan participant dies.
Designated Beneficiaries Not Always the Same as Beneficiary Designation
First must come an understanding of what “designated beneficiaries” are. It all starts with a “beneficiary designation.” Upon establishing an IRA or retirement plan, IRA owners and plan participants typically designate, or name, individuals or entities that are entitled to all or a portion of any remaining account assets upon death. If they do not name any primary beneficiaries, the default beneficiary described in the plan agreement will receive the assets. Very often—though not always—it is the decedent’s estate rather than a person.
After the IRA owner’s or plan participant’s death, the financial organization or plan administrator looks to the beneficiary designation. Primary beneficiaries named as of the date of death (either by election or default) that still have a balance in the IRA or plan on September 30 of the year following the year of death—otherwise known as the “determination date”—then become designated beneficiaries.
Beneficiaries who took a lump sum distribution of their portion of the account before the determination date and those beneficiaries who have filed a valid disclaimer are not considered designated beneficiaries. They are disregarded when determining the payout options for the remaining beneficiaries. Note that if a beneficiary dies between the time of the IRA owner’s or plan participant’s date of death and the determination date, the deceased beneficiary is still considered a designated beneficiary as of the determination date.
Determination Date Affects Distribution Options
The determination date is the cut-off date for identifying which beneficiaries still have an interest in the IRA or plan for the purpose of providing them with the correct distribution options for their inherited assets, and properly calculating life expectancy payments.
Depending on when the IRA owner or plan participant died and what the plan agreement allows for beneficiary distribution options, beneficiaries may choose to take distributions annually over their own life expectancy. Beneficiaries of Traditional IRA owners and plan participants who died before their required beginning date (generally April 1 of year following age 70½) may have the option to take distributions any time in any amount over the five years following death, as long as their portion of assets is depleted by the end of those five years. This “five-year rule” applies to Roth IRAs as well, without the required beginning date condition. Spouse beneficiaries have additional choices, such as transferring or distributing and rolling over the inherited assets to their own IRA, or possibly delaying life expectancy payments.
The option of taking annual life expectancy payments requires that a beneficiary withdraw a certain minimum amount from the IRA or plan each year, starting with the year after the year of death. Be aware that the beneficiary may take more than the annual minimum, up to and including a lump sum distribution.
The minimum amount is calculated by dividing the previous year’s December 31 account balance by a life expectancy factor based on the designated beneficiary’s age (If the beneficiary is older than the deceased account owner, and death occurred after that individual’s required beginning date, the deceased’s life expectancy is used to determine the minimum amount.). In the case of multiple designated beneficiaries, the life expectancy of the oldest is used unless separate accounting of each beneficiary’s balance has been established timely (by the end of the year following the year of death). Thus, it’s crucial to identify the designated beneficiaries as of the determination date so that all ages can be taken into account—if need be—to correctly calculate life expectancy payments.