by Bob Rywick

The owner of a traditional IRA who designates several beneficiaries will be putting a younger beneficiary who wants to keep required minimum distributions as small as possible at a disadvantage. This is because the distribution period will be determined by the life expectancy of the oldest beneficiary.

The IRA owner can solve this problem by breaking up the IRA into a number of separate IRAs through trustee-to-trustee transfers, and by naming a different beneficiary for each of the separate IRAs.

The IRA owner could also achieve the desired result by dividing the original IRA into separate sub-accounts with a different beneficiary for each sub-account. The sub-accounts can also be established after the owner’s death. The 2002 Final Regulations on RMDs confirm the policy previously contained in the 2001 Proposed Regulations and in Internal Revenue Service’s letter rulings.

Under this policy, the RMD rules apply separately to each sub-account, effective for years after the year in which the sub-accounts were created, or the IRA owner’s date of death, if later.

For the sub-account of an IRA to be treated as a separate account for RMD purposes, it must be established no later than the last day of the year following the year of the IRA owner’s death. Additionally, a separate accounting must allocate all post-death investment gains and losses for the period before the sub-accounts were established on a pro rata basis in a reasonable and consistent manner among the sub-accounts.

After the sub-accounts are established, separate accounting can provide for separate investments for each sub-account so that gains and losses from the investments of a sub-account are only allocated to that sub-account. Alternatively, investment gain or losses can continue to be allocated among the separate sub-accounts on a pro-rata basis. A separate accounting must allocate any post-death distribution to the sub-account of the beneficiary receiving that distribution.

Where there are multiple beneficiaries for an inherited IRA, a timely splitting up of the account into subaccounts can yield important tax benefits for each beneficiary.

How splitting up the IRA account can benefit the surviving spouse. If the IRA owner had designated his spouse and other family members (e.g., children) as beneficiaries of an IRA, then, unless the IRA is split up, after the owner’s death the surviving spouse will not be able to either:

...Roll over her share of the IRA into an IRA in the spouse’s name; or,

...Elect to treat the decedent’s IRA as the surviving spouse’s own IRA.

This is because the election to treat the decedent’s IRA as the surviving spouse’s own IRA is available only if the spouse is "the sole beneficiary" of the IRA and has an unlimited right to withdraw amounts from it.

The determination of whether the surviving spouse is the sole beneficiary is made as of Sept. 30th of the year following the year the IRA owner died. If the surviving spouse is not able to treat the IRA as his own, the following potential benefits will be lost:

(1) The surviving spouse will not be able to use the Uniform Lifetime table based on his own age to determine RMDs. Instead, the single life table will have to be used based on the age of the oldest beneficiary (who will usually be the surviving spouse, but may not be, e.g., the oldest beneficiary could be a sibling of the deceased spouse who is older than the surviving spouse). As a result, distributions will have to be made over a shorter period and RMDs will be larger.

(2) The surviving spouse will not be able to name his own beneficiaries for the IRA. If the surviving spouse is able to, and does name, a beneficiary, the period over which the IRA must be distributed may be extended if there is a balance remaining in the IRA when he dies. That balance could be distributed over the life expectancy of the surviving spouse’s beneficiary.

(3) The surviving spouse will not be to defer taking RMDs until the year after he reaches age 70-1/2. If the surviving spouse is able to, and does elect to, treat the IRA as his own, and is under age 70-1/2, he can elect to delay taking RMDs until April 1 of the year after he becomes 70-1/2.

Observation: If one of the beneficiaries is not an individual (or a trust whose beneficiaries are treated as the designated beneficiaries of the IRA), the consequences for the surviving spouse could be even worse. In such a case, the IRA will be treated as having no designated beneficiary even if the surviving spouse is one of the beneficiaries, and the method of distribution will depend on whether the IRA owner died before or after RMDs began.

If the owner died before RMDs began, the entire amount in the IRA would have to be distributed by Dec. 31 of the calendar year containing the fifth anniversary of the IRA owner’s death. If RMDs began before the IRA owner’s death, distributions would be made based on the owner’s life expectancy as of the year of death reduced by one for each year after the owner’s death.

Splitting up the IRA into sub-accounts with the surviving spouse as the sole beneficiary of one of the sub-accounts will give the surviving spouse the option of electing to treat the IRA as her own and get all the benefits that election provides.

How splitting up the IRA account can benefit beneficiaries other than a surviving spouse. Beneficiaries other than the surviving spouse also can benefit by splitting a single IRA into sub-accounts. While a non-spouse beneficiary cannot elect to treat the decedent’s IRA as his own, by splitting the IRA into sub-accounts, each beneficiary’s RMD can be determined by his own life expectancy and not by the life expectancy of the oldest beneficiary.

While the oldest beneficiary will not get a lower RMD as a result of splitting the IRA into sub-accounts, he may benefit by being able to direct how his share of the IRA assets are invested, e.g., in higher yielding securities.

The other beneficiaries also may want to direct how their shares of the IRA should be invested. Of course, if one of the beneficiaries is not eligible to be a designated beneficiary, splitting the IRA into sub-accounts will enable the eligible beneficiaries to take RMDs from their sub-account over each beneficiary’s own life expectancy. Otherwise, distributions would have to be taken as mentioned in the observation, above, depending on whether the IRA owner died before or after required distributions began.

Steps to take after the IRA owner dies. After the owner dies, the IRA can still be split up into sub-accounts. As long as this is done before the end of the year after the IRA owner’s death, this will be effective to treat the individual beneficiary of each IRA as the sole designated beneficiary of a separate IRA for purposes of determining RMDs. If the surviving spouse is the sole beneficiary of a sub-account, she can elect to treat that sub-account as her own IRA.

Example: Your client’s wife, who was 65 when she died on March 8, 2002, designated him as the beneficiary of half of her IRA, their son, Jack, as the beneficiary of one-fourth of the IRA, and their daughter, Louise, as

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