Let’s talk about something way more exciting than it sounds: beneficiary designations, why they’re so important, and what happens when someone inherits your retirement accounts.
Stay with me—this isn’t just paperwork! Setting up the proper beneficiaries helps make sure loved ones inherit your hard-earned money smoothly, with fewer headaches, taxes, and legal complications. If you might be inheriting a retirement account someday, it’s important to know your payout options.
A Quick Reminder About Beneficiaries in General
The importance of keeping your beneficiary designations up to date can’t be overstated. These designations override your will, so we work closely with our clients to regularly review beneficiaries, especially after major life events such as marriage, divorce, or the birth of a child.
Retirement accounts, life insurance, annuities, and even some bank or investment accounts all rely on these forms to determine who inherits your accounts. A quick beneficiary review can prevent costly mistakes and increase the likelihood that your legacy is distributed according to your wishes.
What Happens When Someone Inherits a Retirement Account?
Okay, so we know that when a loved one passes away, retirement accounts follow the beneficiary designations. Suppose you inherit one of these accounts; you’ll probably open a Beneficiary Designated Account (BDA), and these account designations determine how the money is withdrawn and can significantly impact taxes and timing of withdrawals.
Here’s a quick breakdown of the most common payout options for BDAs:
1. Inherited IRA (a.k.a. Beneficiary IRA)
If you’re not the spouse and inherit a traditional IRA or retirement account, welcome to the 10-Year Rule, which means what it sounds like: you have 10 years to withdraw the funds from the account. You can withdraw money at any time within that period, but by year 10, the full amount must be distributed.
2. Spousal Rollover IRA
Surviving spouses can roll the inherited account into their own IRA, treating it as if it were their own account, possibly delaying the required distributions or continuing tax-deferred growth, providing flexibility that non-spouse beneficiaries typically don’t provide.
3. Inherited Roth IRA
Alright, now let’s move on to Roth IRAs. Non-spouse beneficiaries still face the 10-Year Rule, however, the good news is distributions are tax-free (yay!), assuming certain requirements are obtained.
4. Eligible Designated Beneficiaries (EDBs)
EDBs are certain folks who qualify for more flexible payout options, like stretching distributions over their own life expectancy. EDBs include surviving spouses, minor children, disabled and/or chronically ill individuals, and beneficiaries less than 10 years younger than the account owner.
5. Estate, Trust, or No Named Beneficiary
If the account lists an estate, a trust, or no beneficiary at all, distributions follow the 5-Year Rule if the original owner passed before starting Required Minimum Distributions (RMDs). If they had already begun RMDs, payouts follow their current schedule, and this option offers the least flexibility with strict deadlines.
The Bottom Line (Whether You’re Planning or Inheriting)
Whether leaving a legacy or inheriting an estate, everyone deserves certainty, not guesswork. Whether you’re managing your own accounts or preparing for an inheritance, we’re here to help you make smart, stress-free decisions. Feel free to reach out, and we can help you focus on what matters most to you and your loved ones.
Distributions from traditional IRAs and employer sponsored retirement plans are taxed as ordinary income and, if taken prior to reaching age 59 ½, may be subject to an additional 10% IRS tax penalty. Tax Free - Income may be subject to local, state and/or the alternative minimum tax.