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DON’T FEAR THE 5-YEAR RULE

By Andy Ives, CFP®, AIF®
IRA Analyst

Prior to 2002, a default option for paying out required minimum distributions from an inherited IRA to a beneficiary was the 5-year rule. If the IRA owner died before their required beginning date and an election was not made in a timely manner, the account had to be closed by December 31 of the 5th year following the year of death. In 2002, new regulations issued by the IRS changed the default payout to the life expectancy of the designated beneficiary. The 5-year requirement for most beneficiaries was eliminated.

However, over a decade and a half later, many designated beneficiaries still think they can be stuck with the dreaded 5-year payout. While a 5-year payout is an option, it is not the requirement for living, breathing people under the tax code. The only entities required under the current rules to empty an IRA within 5 years are “nonperson” beneficiaries (i.e. estates or charities), and that only applies if the original account owner died before their required beginning date (RBD). Of course, most charities and estates elect a lump sum payout, so the 5-year requirement is essentially extinct.

The only time a designated beneficiary would default to the 5-year rule would be if the IRA document required it, which would be extremely rare.

Here is a basic overview of a beneficiary’s options after an IRA owner passes away:

Owner Dies Before Their RBD

– Surviving Spouse Beneficiary – Can choose the 5-year payout; can take RMDs based on their own single life expectancy (recalculated); or can do a spousal rollover into their own IRA.

– Non-spouse Beneficiary – Can choose the 5-year payout; or can take RMDs based on their own single life expectancy (non-recalculated).

– Non-person Beneficiary – Must close the account within 5 years.

Owner Dies On or After Their RBD

– Surviving Spouse Beneficiary – Can take RMDs based on the longer of their own single life expectancy (recalculated) or the deceased spouses remaining single life expectancy (non-recalculated) had they survived. A surviving spouse can also elect to do a spousal rollover.

– Non-spouse Beneficiary – Can take RMDs based on the longer of the beneficiary’s own single life expectancy (non-recalculated) or the deceased IRA owner’s remaining single life expectancy (non-recalculated) had they survived.

– Non-person Beneficiary – Can take RMDs based on the deceased IRA owner’s remaining single life expectancy (non-recalculated) had they survived.

Of course, much of this could go up in smoke if the SECURE Act is passed into law. However, for the time being, don’t fear the 5-year rule.

https://www.irahelp.com/slottreport/don%E2%80%99t-fear-5-year-rule

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Investment advisory services are offered through Foundations Investment Advisors, LLC and is a SEC registered investment advisor.