Part Two in a series about IRA Required Minimum Distributions
It has been fifteen years since Rob and Gina were first subject to the Required Minimum Distribution (RMD). They both turned 85 this year, and as with so many events in their lives, they passed away within days of one another.
Despite taking the RMD every year, their respective IRA account balances have grown. These balances now transfer to the beneficiaries, their three surviving kids, Robby, Berta, and Pete, two grandkids, 18-year-old Heather and 15-year-old Henry, from their son Joseph, who died in the line of duty, and one charityi.
Pete followed dad into the family furniture business which got pummeled by the big chain stores, and now he works for them. Rob and Gina named Pete the executor of their estate.
Now it’s up to Pete to sort through the estate. While he had some idea of their situation, he was stunned to learn the details of their planning. Within a month of their deaths, he gave copies of the death certificates to their financial advisor.
Rob and Gina named each other as primary beneficiary, but since they both passed before any death distributions occurred, the contingent (or secondary) beneficiaries became the designated (or primary) beneficiaries. Pete discovered that each of the six IRA accounts had its own set of designations, and therefore each account required separate paperwork from each of its individual beneficiaries.
Wait a minute. How did you get six IRA accounts? And why would they do that?
Rob and Gina were very intentional about the way they wanted their wealth distributed, and two of their lineage had reasons for which they separated the funds.
Berta always worked, sometimes two jobs at once, to provide for her kids. Rob and Gina never liked her lazy and abusive husband Jack, so they segregated her shares and used a special irrevocable IRA Beneficiary trust to prevent him from gaining access to the funds.ii
They didn’t include the trust for any of the other beneficiaries, because that would limit their abilities to withdraw the funds at their discretion.
The trust was deemed an accumulation trust, retaining the annual RMD amounts and Rob & Gina’s RMD schedule. The trust paid high income tax rates, but it retained control of the money until the trustee distributed it to Berta under the very strict guidelines dictated by the trust.
Later in life, Berta managed to break free of Jack’s influence and funds from the trust were available to help her re-establish herself.
Joseph’s widow Mary remained diligent about keeping Heather and Henry in Rob and Gina’s lives, even after she re-married, to another officer, Michael. Therefore, they separated the grandkid’s shares into separate IRA accounts years ago and agreed not to touch the funds; they never took an RMD from these IRA accounts.
The annual RMD amount calculation included all the account balances, but they always took the annual distributions from their other accounts. And, because they weren’t taking the funds from the “grandkids’” accounts, these portfolios contained the most aggressive investments they owned.
Mary became the custodian of 15-year old Henry’s account for the first few years. Mary understood that each of the grandkids would be required to take a small taxable distribution from their inherited IRA every year. She knew Rob and Berta wanted the funds to help provide for college, a first home and seed their respective retirement funds.
Unfortunately, at 18, Heather had the legal right to take all the money out of her account. She claimed to honor her grandparents’ wishes, but by the time she dropped out of college she had squandered their bequest.
Mary’s financial parenting was more successful with her son. Every year on his birthday, they withdrew his Required Minimum Distribution amount and he selected an investment for redeploying it. One year, he bought the equipment to start a landscaping business. Other years, he bought mutual funds or individual stocks. Henry eventually retired, still maintaining his inherited IRA, taking only the RMD from it each year.
Robby left town on a motorcycle shortly after high school, ultimately settling across the country where he married Loraine, became a self-employed electrician, and raised a family. Before Facebook appeared, he almost never communicated with his father or siblings, but he talked with his mom regularly. She designated 25% of her balance to him, while dad left only 5% of his account to Robby, and gave 20% to charity instead.
Robby chose to take his share in cash, so he got a check from each of the IRAs. He had the foresight to have income taxes withheld from the distributions and used the money to buy a diesel pusher motorhome. They toured the country as full-time RV’ers during the go-go years of retirement. became “campground hosts” during the slow-go years, and moved into assisted living facilities during their no-go years.
Pete had to work with the charity to get proper documentation about its officers and tax status, but once the paperwork was finalized, the IRA custodian cut a check and the charity put the funds immediately to work. No taxes were paid on this distribution, as the IRS code allows contributions directly from IRA accounts.
Pete and his wife Sally are confident that they can live on her teacher’s pension, his Social Security, and their investment accounts. He and Sally decided to honor his parents by scheduling the RMD from his dad’s IRA in mid-June and use it to support an Independence Day celebration in their community. From his mom’s RMD they took the distribution in two separate amounts timed to coincide with their annual property tax bills.
IRA Beneficiaries can be treated differently, according to their individual situations. It is wise to consider in advance the likely outcomes of your passing substantial assets when you die. As part of our annual review process with our advisory clients, we ask them to verify that the beneficiary designations are the way they want them and we help them understand their choices. In most cases, they don’t change from year-to-year, but when family situations change, so can the beneficiary designations.
The above are hypothetical examples and not representative of any specific situation. You should discuss your specific situation with the appropriate professional.
iIt is assumed that Rob and Gina were primary beneficiaries on each other’s accounts, but the kids were the contingent beneficiaries on both accounts, and since both passed before either’s account was settled, the contingent beneficiaries became the primary beneficiaries.
iiDesignating a trust as a beneficiary of an IRA is allowable, but the ramifications must be understood. Trusts pay taxes and are subject to different withdrawal rules than individual beneficiaries. Seek counsel on the tax code before naming a trust as the beneficiary of your IRA.