This topic confuses even veteran IRA practitioners.
Question: Our client Alma died. Her IRA beneficiary designation form reads, "I name my son Hugo as my primary beneficiary if he survives me. If he does not survive me, I name his three children as my contingent beneficiaries, in equal shares." Alma died in June, Year 1. Hugo survived her but then was killed in a car accident in December, Year 1. He had never taken any distributions from the inherited IRA. He had not even gotten around to retitling it as an "inherited IRA" in his name, and he had not named any successor beneficiary.
The IRA documents say that if a beneficiary dies before withdrawing all the funds from the inherited account, the account passes to a successor beneficiary named by the original beneficiary (Hugo in this case) or, if he failed to name a successor beneficiary (which he did), to the estate of the original beneficiary. Hugo's entire estate passes (under Hugo's will) to his surviving spouse Portia.
There is now substantial disagreement about who gets this money: Hugo's children, as Alma's originally named contingent beneficiaries? Or Portia, as beneficiary of Hugo's estate? The other question is, what Applicable Distribution Period applies (since Hugo died before the "beneficiary determination date"). Help!
Answer: You have hit on the two perennial questions that arise when a beneficiary, having survived the original participant, later dies before cashing out all of the inherited account. The two questions are: Who gets the money now? And what is the Applicable Distribution Period?
Who Gets the Money?
Generally in this scenario, the money goes to a successor beneficiary named by the original beneficiary or (if the original beneficiary did not name any successor) to the estate of the original beneficiary.
The "contingent beneficiary" named in the participant's beneficiary designation form is completely out of the picture. Read the beneficiary designation form: It says the money goes to the primary beneficiary if he or she survives me. The contingent beneficiary gets something only if the primary beneficiary did not survive the participant. Since in your case the primary beneficiary did survive the participant, the contingent beneficiary is simply erased from the board; he or she doesn't come back into the picture even if the primary beneficiary (having survived the participant) later dies before having cashed out the entire account.
There are two quasi-exceptions to the above statement.
First, if the primary beneficiary survives the participant but later "disclaims" the account by means of a qualified disclaimer, he is treated as having predeceased the participant--he drops out of the picture. In that case the contingent beneficiary comes back in to the picture, because he is entitled to the money if the primary beneficiary did not "survive" the participant, and disclaimer causes the primary beneficiary to be deemed not to have survived the participant.