• / Free eNewsletters & Magazine
  • / My Account
Home>Practice Management>Retiring With Natalie Choate>What Happens When the Beneficiary Dies?

Related Content

  1. Videos
  2. Articles
  1. Financial Advisers: How To Make a Great Website

    Gareth Thompson of [codepotato] outlines the essential steps to building--and maintaining--a great financial adviser website.

  2. Cloud May Have Silver Lining for Investors

    Tech director Grady Burkett looks at the impact of cloud computing with StockInvestor editor Matt Coffina.

  3. Measuring Moats in Social Media

    Twitter , Facebook , LinkedIn , and Google each have moats, but there are some interesting distinctions among their competitive advantages.

  4. Wide-Moat Search Business Still Google's Growth Engine

    The search giant's first-quarter results underscored the fact that even with Android's explosive growth, Google's bread and butter remains its still-fast-growing advertising business, says Morningstar's Rick Summer.

What Happens When the Beneficiary Dies?

This topic confuses even veteran IRA practitioners.

Natalie Choate, 09/12/2014

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.

Second, with a trusteed IRA it is possible for the original participant to dictate who the successor beneficiary is. The participant can dictate that, if the primary beneficiary (having survived the participant) later dies while there is still money in the account, that money will pass to the participant's chosen successor beneficiary, not to the estate of the primary beneficiary. This is one of the attractions of the trusteed IRA for some clients. But Alma's account was a custodial IRA and did not have this feature.

What Is the Applicable Distribution Period?
This is confusing. We all know that, generally, the Applicable Distribution Period is the life expectancy of the designated beneficiary. In this case Hugo was the designated beneficiary. If he had lived, the ADP would clearly be his life expectancy.

What muddies the waters is the "beneficiary finalization date" or "beneficiary determination date," which is Sept. 30 of the year after the year of the participant's death. IRS regulations tell us that the "beneficiary" of an account is all the people and entities who (as of the date of death) might possibly share in this account, "minus" any beneficiary who ceases to have any interest in the benefits prior to that beneficiary finalization date.

So, for example, if an IRA is left to two children and a charity, but the charity's share is paid out in full prior to the beneficiary finalization date, the charity does not "count" as a beneficiary anymore. The Applicable Distribution Period will be based on the two children being the sole beneficiaries of the account.

Similarly, a person who is a beneficiary as of the date of death, but who disclaims his or her entire interest in the account by means of a qualified disclaimer prior to the beneficiary finalization date, "drops out": He or she doesn't count as a beneficiary any more, just as if he or she had predeceased the IRA owner.

That brings us to Hugo. It seems as though he no longer has an interest in the account, because he died in December, Year 1, which was prior to the beneficiary finalization date for Alma's account (Sept. 30, Year 2). But ... the IRS regulations tell us that a beneficiary's death prior to the finalization date does NOT cause that beneficiary to cease to be a beneficiary for minimum distribution purposes. That makes sense, since his estate still "owns" the account.

So the answers to your questions are clear, though maybe confusing: Under the IRA account documents, the IRA now belongs to Hugo's estate (since he survived Alma, and thus became entitled to ownership of the inherited IRA, but died without having named any successor beneficiary to himself). And under the IRS regulations, the Applicable Distribution Period is still Hugo's life expectancy, since his death did not "erase" him as a beneficiary.

Where to read more: For more detail on how to compute and pay minimum required distributions, see Chapter 1 of the author's book Life and Death Planning for Retirement Benefits (Ataxplan Publications; 7th ed. 2011). 

Natalie Choate will be speaking at a location near you if you live in Portland, Maine (Sept. 16, 2014); Florham Park, N.J. (Sept. 18, 2014); St. Louis (Sept. 22, 2014); Minneapolis (Oct. 1, 2014); Springfield, Ma. (Oct. 8, 2014); Atlanta (Oct. 24, 2014); Woodstock, Vt. (Oct. 29, 2014); Palm Beach (Nov. 5, 2014) or Orlando (Jan. 15, 2015; Feb. 19, 2015; and May 15, 2015), Fla; South Bend, Ind. (Nov. 13, 2014); Eugene, Ore. (Nov. 14, 2014); Plymouth, Mich. (Nov. 18, 2014); Washington, D.C. (Dec. 4, 2014); San Francisco and Palo Alto, Calif. (April 23, 2015); Doylestown, Pa. (May 19, 2015); or Chattanooga (May 20, 2015) or Knoxville (Sept. 9, 2015), Tenn. See all of Natalie's upcoming speaking events.

Natalie Choate practices law in Boston with Nutter McClennen & Fish LLP, specializing in estate planning for retirement benefits. Her book, Life and Death Planning for Retirement Benefits, is a leading resource for professionals in this field.

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar. The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.

blog comments powered by Disqus
Upcoming Events

©2014 Morningstar Advisor. All right reserved.