In Part One, linked here, I explained why I became interested in learning about IRAs and their distribution policies and threw in there a few of the more common questions someone may have. The big question is: What happens when I die and what is the required minimum distribution (RMD) -- in other words, the minimum amount to be withdrawn?
All my answers will be RMD related. You can always take more than the RMD, but you have to take the RMD to not be penalized by the IRS. Also, I am going to use the surviving spouse as female because females live longer, and I don't want to make this any harder than it already is with mixing genders.
How The Account Should Be Named Upon Your Death
This is very important. It has to be known that you were the original owner of the IRA and that it is now "for the benefit of" (F/B/O) an heir, be it a spouse or otherwise. The way to title the account is this:
Doctor Dividend, IRA (deceased, October 42, 1868) F/B/O Penny Dividend, beneficiary
By doing it this way, it shows who was the original owner, when they died, and who received the IRA.
The other extremely important thing is that the beneficiary puts their Social Security number on the new account and assigns their own primary and contingent beneficiaries, which I will explain later.
Your Spouse Is The Sole Primary Beneficiary
This is the easiest one to explain, and yet it has numerous possibilities on what you can do with multiple scenarios, so it could become complicated. This flexibility is only allowed IF your spouse is 100% the primary beneficiary. If there is any splitting with another beneficiary on the account, then she would go into the second case of situations, which is worse off for her. I will go through four scenarios that only deal with IRAs that require RMDs. Hence, a Roth given to your spouse does not have to have any withdrawals, and is not applicable to any of the situations below.
Scenario 1 - The Cougar Wife
You are 72, your wife is 78. When you die, she has the option of rolling the IRA into her account and using her age to determine future distributions via Table III (the divisor is 20.3), link is here. Or, she has the extra option of keeping the account separate (naming it as above) and using your age and your distribution timeline (divisor of 25.6) until the funds run out.
Scenario 2 - The Hugh Hefner Scenario
You are 86 and well, she's not. You have been taking the RMDs as a single man, and now you just got married to your granddaughter's best friend, who is 31 years old. You make her your sole primary beneficiary, which allows you to change the distribution divisor. As the 86-year-old, the divisor was 14.1. But you now use Table 2 and your new divisor is 52.4 because between the two of you, somehow she is supposed to live longer than you. When you die of "natural causes with a huge grin on your face," your wife has three wonderful options:
Keep the account separate and titled as I explained above and continue to take withdrawals according to Table 1 in a slightly different fashion. You died when she was 31 years old. For the next year, she looks at Age 32 (with a divisor of 51.4) and for every subsequent year, subtracts 1 from the initial divisor of 51.4 to figure out future RMDs (I'll give an example with numbers later in the article). OR
Roll the account to her name and because she is under 70.5 years of age, lets it compound tax-deferred until the RMD is necessary. OR
Find someone who went through the Gulf War and not through the Korean War.
Here's the other huge benefit she has. She can roll this into her account at any time. So she can start with option 1 for five years, finds another sucker (I mean husband), and at that point, she can then transfer it all under her name and does not have to take any further withdrawals until 70.5 years.
Scenario 3 - The Everyone Else Category
I am 36, my wife is 35. If something were to happen to me in the next 10 days, the options are just like above:
1) Keep the account separate and titled as I explained above and continue to take withdrawals according to Table 1 in a slightly different fashion. I died when she was 35 years old. For the next year, she looks at Age 36 (with a divisor of 47.5) and for every subsequent year, subtracts 1 from the initial divisor of 47.5 to figure out future RMD. OR
2) Roll the account to her name and because she is under 70.5 years of age, lets it compound tax-deferred until the RMD is necessary.
To see what this looks like with numbers, the IRA account value as of December 31, 2012 is $240,000. If my wife is to be 36, her RMD for 2013 is $240,000/47.5 = $5052.63.
For 2014, assuming the value is $250,000 at the end of 2013, the RMD will be $250,000/46.5 = $5376.34. She will continue to just subtract one every year from the bottom number until the account is exhausted (which is what other inheritors do anyway) if she continues down this path.
Here's the other huge benefit she has. Just like the above scenario, she can roll this into her account at any time. So she can start with option 1 for any number of years and at any future point, she can then transfer it all under her name and does not have to take any further withdrawals until 70.5 years.
Scenario 4 - The Wife is named as Primary with Other Beneficiaries
You have now screwed things up (potentially). These top three scenarios only work when the spouse, and only the spouse, is the primary beneficiary. If your want your wife, Penny, and your son, Quarter, to each have some of the IRA when you die (80:20 to Penny of a $500,000 IRA for our example), the only way for Penny to have all the flexibility possible is to split the IRA, so you have this:
IRA #1 - $400,000 value - Penny, spouse, 100% beneficiary
IRA #2 - $100,000 value - Quarter, son, 100% beneficiary
While you are still alive, you total it together to see the whole account value to calculate the RMD required like I explained in Article 1 (linked above), but this makes everyone happy. This idea of splitting IRAs is what we will do moving forward when talking about inheritors who are not your spouse. As this article went much longer than expected, I will do one more article to talk about non-spouse inheritors, including charities.