IRS Expands Spousal Beneficiary Option
New IRS Guidelines Provide Greater Flexibility for Surviving Spouses in Inheriting Retirement Accounts
In July 2024, the IRS released final required minimum distribution (RMD) regulations that contained many of the same provisions found in the proposed regulations from two-and-a-half years ago. There were also some important changes, which we will cover in the upcoming weeks and months. One significant revision involves how spouse beneficiaries can treat a deceased IRA owner’s assets. Because married IRA owners typically name their spouse as the sole beneficiary (or at least a partial beneficiary), this rule change may affect how such beneficiaries proceed when they inherit an IRA from a spouse.
The “Old Rule”
For decades, spouse beneficiaries were able to take a deceased IRA owner’s assets as their own at any time. This could be accomplished either through a direct trustee-to-trustee transfer or through a distribution and a rollover within 60 days. While the net result in either of these approaches is the same, the IRS took a narrower view of what “treat as own” meant. Specifically, the IRS dictated that sole spouse beneficiaries could take the decedent’s IRA as their own through one of three methods:
Fail to take an RMD from the decedent’s IRA
Make a contribution to the decedent’s IRA
Transfer the decedent’s IRA to the spouse beneficiary’s own IRA
In the first two methods, the decedent’s IRA is deemed to be the spouse beneficiary’s IRA. In the third method, the assets are actually moved to the spouse’s own IRA, and this is the method that most spouse beneficiaries have used to treat IRA assets as their own.
The Rule Under The Proposed Regulations
Under the proposed RMD regulations, the rules changed. Because of the newly created 10-year rule, spouse beneficiaries could “game the system” if the IRS didn’t plug a loophole. Specifically, the IRS required sole spouse beneficiaries to make an election to treat a decedent’s IRA as their own by the later of 1)
December 31 of the year following the IRA owner’s death or 2) December 31 of the year of the spouse beneficiary’s first RMD distribution year (e.g., the year the spouse turns 73). After that point, spouse beneficiaries could move the decedent’s assets into their own IRA but would have to accomplish this through a rollover rather than through a transfer. In addition, the spouse could not roll over any assets that would be considered “hypothetical RMDs”—that is, the distributions that would have been required because both the decedent and the beneficiary had attained the applicable age for taking RMDs.
Example
Ben and Jen are both 70 when Ben dies. Jen elects the 10-year rule thinking that she can avoid RMDs by taking Ben’s IRA assets as her own in the ninth year—and then starting RMDs from her own IRA. Unfortunately for Jen, the proposed regulations would require her to determine what her RMDs would have been in years 3 – 9 and to distribute those RMDs before rolling over the remainder of the assets to her own IRA.
“Treating as Own” Under the Final Regulations
Now, the whole process will be a bit easier for sole spouse beneficiaries, including those who separately account for their portion of an IRA that has multiple beneficiaries. The final regulations eliminate the deadline described above and replace it with a much more simple, practical rule. Essentially, the election for surviving spouses to treat the decedent’s IRA as their own can be made in any calendar year provided that the election does not apply to amounts that would be treated as RMDs because of the beneficiary’s age.Essentially, the election can be made only after the amounts treated as “hypothetical RMDs” for that calendar year have been distributed from the IRA.
The formula for calculating hypothetical RMDs is not particularly complicated, but we will dive into those details at a later time. In short, spouse beneficiaries who have elected the 10-year rule and have reached the applicable distribution year will have to take any missed RMDs—reduced by the distributions taken from the IRA since reaching the first RMD year—before electing to take the remaining IRA balance as their own.In addition, the following factors apply:
The surviving spouse must be the sole beneficiary (either because no other beneficiaries were named or because separate accounting is in place by December 31 of the year following the IRA owner’s death).
The surviving spouse must have an unlimited right to withdraw amounts from the IRA.
If a trust is named as beneficiary of the IRA, the election to take as its own cannot be made, even if the surviving spouse is the sole beneficiary of the trust.
Stay Informed
The new rules that affect surviving spouse beneficiaries taking IRA assets as their own may not affect howIRA owners designate their beneficiaries. But knowing these rules—and communicating them to spouse beneficiaries—is critically important for financial organizations who want to provide the best service to their clients.