How one 94-year-old Increased his in life expectancy nearly 10 years
Posted August 6, 2009
Every now and then, a situation comes along that allows a taxpayer to benefit from an obscure, little known tax provision. Such was the case of "Archie" when he inherited his nephew's IRA.
"Jack," a long-time client of mine, passed away at the beginning of this year at the age of 73. A life-long bachelor with no children, no brothers or sisters, and no nieces and nephews, Jack had no usual beneficiary to leave his IRA to. He did, however, have a favorite uncle—Archie—with whom he was very close. Although Archie was 20 years his senior (93) and did not need the money, Jack wanted his uncle to have these funds should something happen to him.
In general, it's fairly unusual to see a 93-year-old beneficiary on any type of account; but in the rare case it happens, it's usually the spouse of someone similar in age. In Archie's case, however, he was inheriting the account from someone substantially (relatively speaking, of course) younger. As a result, a unique situation presented itself when Archie came in to see me to discuss his inheritance.
Generally speaking, when an IRA owner dies, if they have named a (designated) beneficiary, that beneficiary is able to extend distributions out over their life expectancy (as determined by the IRS). Distributions for non-spouse beneficiaries must begin in the year following the year the IRA account owner died and the percentage that must be withdrawn each year increases as the beneficiary ages.
To calculate the required minimum distribution (RMD) on an inherited IRA, in the year after the death of the IRA owner, a non-spouse beneficiary must first go to the IRS single life expectancy table and determine their "factor." The minimum distribution is the preceding year's December 31st account balance divided by the factor. In each subsequent year, the factor is reduced by 1, until the account is emptied.
At 94 (age in the year after death) Archie's factor was 4.3 years. As such, he would have to withdraw all the funds within 5 years...right? (4.3 years in year 1, 3.3 years in year 2, 2.3 in year 3, 1.3 in year 4 and the balance in the 5th year) No! Archie actually has over 14 years to empty the account (if he lives that long—but this little-known tax rule may provide just the incentive to keep going). But how?
A little-known rule regarding RMDs states that if an IRA account owner dies on or after their Required Beginning Date (April 1st of the year following the year they turn 70 ½) their beneficiaries can extend distributions out over their own life expectancy OR the life expectancy of the account owner, whichever is longer. Since Jack would have been 74 the year after he died, Archie can use the factor of 14.1 for a 74 year-old instead of his factor of 4.3. So what? Big deal? Archie's probably not going to live 14 more years anyway right? Yes...but even if he doesn't, Archie's beneficiaries (if he names them on his inherited IRA beneficiary form) can continue to stretch distributions over whatever is left of the 14-year schedule after Archie dies.
Well, it may not be millions; but by using the larger factor, Archie (or his heirs) can take less money out of the account now and extend distributions out nearly 10 more years. The tax-deferred growth during this time could lead to significantly more money than otherwise would have been possible.
Most people want to make sure every penny counts. Often times though, it's not one great decision that builds wealth, but a series of small steps, that over time help an individual achieve their goals. Should you find yourself in a similar position to Archie, here are some tips to help you make sure every penny counts.
1: If you inherit an IRA from someone who died after April 1st of the year after they turned 70 ½ and you are older than that person, you can use their life expectancy to determine your "factor." This will allow you to stretch out distributions over a longer time, allowing for more tax-deferred growth.
2: After inheriting an IRA, make sure to name your own beneficiaries. Although they would not be able to use their own life expectancy to determine the "factor," they would be able to continue taking distributions on the same schedule as you.
3: IRAs have all sorts of strange rules and guidelines. Most people, including many financial advisors are not aware of many of these provisions. When dealing with IRAs, make sure to consult a qualified advisor who specializes in this area.
Ed Slott and Company has been called "The Best" sources for IRA advice by The Wall Street Journal, and "America's IRA Experts" by Mutual Funds Magazine. Ed is a widely recognized professional speaker and author. The company’s website is IRAHelp.com.