Unit 5 Beneficiaries of Taxed Preferenced Accounts

Question 1

What is the implication of having multiple beneficiaries on an IRA without splitting the account?

Answer 1

When an IRA has multiple beneficiaries, the distribution defaults to the least advantageous option unless the accounts are split to reflect each beneficiary’s specific status.

Question 2

By what deadline must an IRA be split among beneficiaries to ensure each receives their most favorable payout option?

Answer 2

Splitting the IRA by December 31st of the year following the year of the decedent’s death ensures each beneficiary can utilize their specific advantageous payout option.

Question 3

What defines a non-designated beneficiary for post-death payout rules of an IRA or 401k?

Answer 3

Non-designated beneficiaries are those that do not have a life expectancy, such as estates, charities, or non-qualifying trusts.

Question 4

What are the RMD rules for a non-designated beneficiary if the IRA owner died before reaching the required beginning date (RBD)?

Answer 4

The beneficiary must withdraw all funds by the end of the 5th year following the IRA owner’s death, with no annual RMD requirements within that period.

Question 5

What is the rule for non-eligible designated beneficiaries (non-EDBs) regarding the depletion of an inherited IRA under the Secure Act?

Answer 5

Non-eligible designated beneficiaries must empty the inherited IRA by the end of the 10 years following the original account owner’s death.

Question 6

How do the proposed IRS regulations differentiate RMD requirements for non-EDBs based on the original IRA owner’s age at death?

Answer 6

If the IRA owner died before their required beginning date, non-EDBs have no RMDs until the end of the 10-year period; if the owner died after starting RMDs, non-EDBs must take annual RMDs based on their life expectancy for years one through nine and deplete the account in year 10.

Question 7

Which of the following is NOT considered a non-spouse Eligible Designated Beneficiary (EDB) under the Secure Act?

Answer 7

Non-spouse beneficiaries who are more than 10 years younger do not qualify as EDBs and are subject to the 10-year rule rather than benefiting from the stretch IRA.

Question 8

What is one of the key benefits for a spouse who elects to remain a beneficiary of an inherited IRA instead of doing a spousal rollover before reaching age 59 ½?

Answer 8

By remaining a beneficiary instead of rolling over the IRA into their own account, a spouse under 59 ½ avoids the early withdrawal penalty that would apply if they took distributions from a rolled-over IRA.

Question 9

What option does a spousal Eligible Designated Beneficiary (EDB) have regarding the 10-year rule?

Answer 9

A spousal EDB has the flexibility to elect the 10-year rule, but this option is available only if the original IRA owner died before starting their RMDs.

Question 10

What rule applies to Non-Eligible Designated Beneficiaries regarding the distribution of inherited accounts?

Answer 10

The 10-Year Rule requires that inherited accounts for Non-Eligible Designated Beneficiaries must be fully distributed by the end of the tenth year after the original account owner’s death, as mentioned in the text.

Question 11

Under what condition must Non-Eligible Designated Beneficiaries take RMDs starting the year after the account owner’s death?

Answer 11

If the account owner died on or after their Required Beginning Date, Non-Eligible Designated Beneficiaries must take RMDs like distributions starting the year after death based on their single life expectancy. However, if the NEDB was older than the deceased they can use the deceased single life table.

Question 12

What is a potential drawback of delaying distributions from an inherited IRA to the 10th year for non-designated beneficiaries?

Answer 12

Delaying distributions until the 10th year can lead to a large lump-sum withdrawal, which might significantly increase the beneficiary’s taxable income for that year, resulting in higher taxes.

Question 13

Why might a Roth IRA beneficiary choose to delay distributions until the 10th year?

Answer 13

As Roth IRAs grow tax-free, beneficiaries are incentivized to leave funds in the account until the last possible moment to take full advantage of tax-free growth.

Question 14

For non-designated beneficiaries under the 10-year rule, why might spreading out distributions help minimize taxes?
How might beneficiaries effectively turn the “10-year rule” into an “11-year rule” for inherited IRAs?

Answer 14

It helps keep annual taxable income lower by avoiding a single large distribution that could push the beneficiary into a higher tax bracket.
Beneficiaries can begin withdrawing in the year of the account owner’s death, effectively spreading income over 11 years instead of only 10.

Question 15

What strategy can help minimize the tax burden for heirs inheriting a retirement account under the 10-year rule?

Answer 15

By naming more beneficiaries, taxable income from the inherited account can be distributed across multiple individuals, possibly resulting in lower overall taxes.

Question 16

What is the primary goal of bypassing the spouse and naming children as direct beneficiaries of a retirement account upon the first spouse’s death?

Under what circumstances might the strategy of bypassing a spouse not be advantageous?

Answer 16

By bypassing the spouse, beneficiaries might have two separate 10-year periods to spread their inherited distributions, thereby reducing potential tax burdens compared to a single 10-year period.

If the beneficiaries are subject to higher tax rates than the couple, it may result in higher taxes on distributions, which negates the intended tax efficiency of the bypassing

Question 17

In the context of Roth conversions for beneficiaries, when might it be advantageous for a beneficiary to “gift up” funds to the account owner?

Answer 17

When the beneficiary is in a higher tax bracket and can help cover the tax cost of the conversion, which ultimately benefits them by reducing their future tax burden on inherited funds.

Question 18

What is a potential benefit of using life insurance instead of a Roth conversion for retirement account wealth transfer?

Answer 18

Life insurance can provide a guaranteed death benefit and can be structured to be outside the estate through an Irrevocable Life Insurance Trust (ILIT), offering potential estate tax advantages, as mentioned in the text.

Question 19

What is a major tax advantage of leaving a Roth account to beneficiaries instead of life insurance?

Answer 19

Roth accounts offer tax-free compounding for at least an additional 10 years post-inheritance, whereas interest, dividends, and gains on life insurance proceeds are taxable immediately.

Question 20

What is the primary goal of treating beneficiaries unequally when distributing retirement account assets?

Answer 20

By considering beneficiaries’ tax rates, the strategy aims to minimize taxes paid to the IRS, thereby increasing the net amount each beneficiary receives after taxes.

Question 21

Can a young person be the beneficiary of a CRUT

Answer 21

In order to qualify as a CRUT, a trust must both distribute at least 5% of its assets annually, and have an actuarial value of the remainder interest of the trust equal to at least 10% of the initial contribution to the trust. That required combination makes it impossible to name “young” individuals as the beneficiary of a CRUT (or to even be included amongst a group of named beneficiaries).

Question 22

What is the primary benefit for a pre-59½ surviving spouse to maintain an IRA as an inherited IRA?

Answer 22

To keep access to funds penalty-free should they need to take distributions before reaching age 59½, while avoiding required minimum distributions (RMDs) if the deceased spouse wasn’t yet RMD age.

Question 23

Under what condition might a young surviving spouse consider rolling over an inherited IRA into their own IRA almost immediately?

Answer 23

If they are certain they won’t need to access the funds before reaching age 59½ and their deceased spouse was much older, requiring RMDs sooner.

Question 24

What benefit does Secure Act 2.0 provide to a surviving spouse who chooses to be treated as the deceased spouse for their inherited IRA?

Answer 24

Secure Act 2.0 permits the surviving spouse to be treated as the deceased spouse for RMD purposes, potentially extending the deferral and reducing the size of RMDs if the deceased spouse was younger.

Question 25

Why is a spousal rollover generally the best approach for a surviving spouse who is over 59½ but younger than the deceased spouse? In situations where the surviving spouse is over 59½ and younger than the deceased spouse, why is maintaining the inherited IRA as an inherited IRA not beneficial?

Answer 25

By executing a spousal rollover, the surviving spouse can defer RMDs until they reach their own RMD age, rather than starting distributions based on the deceased spouse's age. It requires starting RMDs based on the deceased spouse's age, potentially leading to earlier required distributions.

Question 26

Why might a year-of-death Roth conversion be a strategic move for the surviving spouse?

Answer 26

The year of death allows the surviving spouse to file jointly one last time, potentially taking advantage of wider income tax brackets and lower rates compared to single filing status in future years, making it ideal for accelerating income via a Roth conversion.

Question 27

What potential impact does a year-of-death Roth conversion have on future Medicare Part B and D premiums, and how can it be addressed?

Answer 27

A higher income in the year of death could lead to increased Medicare premiums (IRMAA) two years later, but the survivor can file Form SSA-44 to report the spouse's death and possibly reduce or eliminate these adjustments, as explained in the text.

Question 28

What option does an Eligible Designated Beneficiary have if an IRA owner dies before their Required Beginning Date?

Answer 28

If the IRA owner dies before the Required Beginning Date, Eligible Designated Beneficiaries have the flexibility to either stretch distributions over their own life expectancy or opt for the 10-Year Rule, allowing for potential strategic tax planning.

Question 29

How are Required Minimum Distributions (RMDs) typically calculated for an Eligible Designated Beneficiary?

Answer 29

RMDs for an Eligible Designated Beneficiary are calculated using the Single Life Table, which provides factors based on the beneficiary's age after the owner's death, decreasing by one each year, as described in the content.

Question 30

What is the method for calculating minimum distributions for Non-Designated Beneficiaries if the owner dies on or after their Required Beginning Date?

Answer 30

If the owner dies on or after their Required Beginning Date, Non-Designated Beneficiaries must make annual distributions calculated on the decedent’s remaining life expectancy, using the appropriate factor from the Single Life Table, as explained in the content. If before RBD, 5 year rule applies

Question 31

Why might individuals choose to leave retirement accounts to charity rather than other types of assets? What is the potential issue when satisfying a pecuniary bequest to a charity with a distribution from a retirement account through a will or trust?

Answer 31

Charities are tax-exempt entities, so they can receive pre-tax retirement accounts without paying taxes, whereas other beneficiaries, like children, would incur taxes on distributions. The trust or estate becomes responsible for the taxes on the distribution without a corresponding deduction, resulting in an unintended tax burden.

Question 32

What is a primary disadvantage of naming an estate as the beneficiary of an IRA or retirement account?

Answer 32

The estate is considered a non-designated beneficiary, potentially requiring faster distribution timings such as a five-year rule instead of the 10-year rule.

Question 33

What is "Income in Respect of a Decedent" (IRD)?

Answer 33

IRD refers to income that the decedent was entitled to receive before their death and would have been taxed if they had received it; therefore, it is taxable to the beneficiary who collects it.

Question 34

What tax benefit is available to beneficiaries who inherit items classified as IRD that are also subject to federal estate tax?

Answer 34

To mitigate double taxation, beneficiaries can claim an income tax deduction corresponding to the estate tax that was attributable to the IRD items in the estate.

Question 35

How is an IRD deduction calculated for a beneficiary inheriting a valuable IRA?

Answer 35

By calculating the difference between the actual estate tax amount and the hypothetical estate tax amount if the IRD items were not included in the estate.

Question 36

How does a beneficiary claim an IRD deduction on their tax return?

Answer 36

As an itemized deduction that can be claimed annually based on the percentage of IRD withdrawn.

Question 37

How can a beneficiary correct a missed IRD deduction?

Answer 37

File an amended tax return for the past three years to claim the deduction for the income previously withdrawn if eligible.

Question 38

What is the primary goal of meeting the "see-through" trust rules for a trust to be treated as a designated beneficiary of an IRA?

Answer 38

To enable the trust to maximize tax deferral by accessing longer distribution timelines, such as the 10-year rule, instead of shorter timelines typical for non-designated beneficiaries.

Question 39

How does a conduit trust handle distributions from an inherited IRA? Which of the following is an advantage of using a conduit trust when dealing with taxes on IRA distributions?

Answer 39

The funds that come out of the inherited IRA must be passed directly to the trust beneficiaries without retention by the trust. By taxing distributions at the beneficiary level, the income benefits from the wider individual tax brackets rather than the compressed trust tax brackets, potentially reducing overall tax burdens.

Question 40

What differentiates a discretionary (accumulation) trust from a conduit trust when an IRA is involved? Why might a discretionary trust face challenges with tax efficiency?

Answer 40

A discretionary trust allows IRA distributions to be retained within the trust and distributed based on the trustee's discretion, whereas a conduit trust requires immediate distribution to beneficiaries. Discretionary trusts may face tax inefficiency because income retained in the trust is taxed at high trust tax rates, which are less favorable compared to individual tax rates.

Question 41

How has the SECURE Act impacted conduit trusts that are named as IRA beneficiaries? Why might the use of a conduit trust as an IRA beneficiary be problematic under the SECURE Act?

Answer 41

The SECURE Act requires that if a conduit trust includes non-eligible designated beneficiaries, it must follow the 10-year rule, making the trust's long-term protection efforts ineffective beyond this period. A conduit trust that adheres to the 10-year rule fails to provide long-term defense for the inherited assets, requiring a shift towards potentially more suitable structures like discretionary trusts for sustained protection.

Question 42

How has the SECURE Act impacted discretionary trusts regarding inherited IRAs? Why might some clients reconsider using a discretionary trust as a beneficiary for their IRA following the SECURE Act?

Answer 42

It limits most discretionary trusts to the 10-year rule for distributions, often resulting in higher taxes due to the compressed timeframe for taking distributions. With the compressed 10-year rule and higher trust tax rates, clients may find the tax costs prohibitively high, influencing them to consider leaving IRAs directly to beneficiaries instead.

Question 43

Why does a corporate redemption type of buy-sell agreement funded with life insurance create significant estate tax complications?

Answer 43

A recent court decision's impact may result in higher estate tax when the decedent's shares are sold to the corporation via a redemption agreement funded with life insurance.

Question 44

✔️ Benefits of a Section 645 Election: Combines the estate and trust into a single entity for income tax purposes Allows the use of the estate's more favorable income tax brackets May use a fiscal year (instead of calendar year, which trusts must use) Avoids the need to file separate Form 1041 returns for both the estate and the trust May provide more flexibility with deductions and administration expenses

Answer 44

❌ Why the Other Options Are Incorrect: a) ❌ Estates can use a fiscal year, unlike trusts which must use a calendar year. So this is actually a disadvantage of not making the election. b) ❌ Not true. The election does not guarantee that all income is taxed to beneficiaries — taxation depends on whether income is distributed or retained. d) ❌ While estates do have broader brackets than trusts, the election doesn't "merge" income — it simply treats the trust as part of the estate for tax purposes, streamlining filing and providing flexibility.