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George F. Bearup, J.D. Senior Legal Trust Advisor

1-Oct-18

IRA Deemed Election

Take-Away: What happens when an IRA owner fails to take his/her full required minimum distribution (RMD) for the year in which he/she dies? The general rule is that the named beneficiary takes and reports that last RMD in his/her income.  However, if the balance of the RMD is not taken prior to the close of that calendar year, the decedent’s surviving spouse as the named beneficiary will be ‘deemed’ to have made an election to treat the inherited IRA as his/her own,  which in turn can lead to bad income tax consequences.

Background: We are all familiar with the Tax Code’s required minimum distribution (RMD) rules when the IRA owner attains age 70 ½. We also know that there is a 50% penalty imposed when the IRA owner fails to take their required minimum distribution for a calendar year. We know, too, that if the IRA owner dies without taking his/her full RMD for the year, the named beneficiary must take the balance of the decedent’s RMD and report it in their taxable income for the calendar year. Less known is what is called the deemed election by the surviving spouse beneficiary to treat the inherited IRA as his/her own.

Example: Archie, age 79, dies owning an IRA with $1.0 million (called for convenience as the Archie IRA.) Archie named his wife Edith, age 72, as the designated beneficiary on his IRA. Because Archie is over age 70 ½, he has to take an RMD for the year. Archie’s RMD is $51,282 for the year in which he died. Suppose that prior to Archie’s death he had taken $50,000 of his  RMD for the year. As Archie’s surviving spouse, Edith must take Archie’s remaining RMD for the year in which he died, or $1,282 and report it in her income for the year. As for the future of Archie’s IRA, Edith has a couple of options to choose from:

  • Inherited IRA: If Edith remains as the beneficiary on Archie’s IRA, she must begin to take RMD’s over her single life expectancy, which RMD is recalculated annually by Edith.
  • Rollover IRA: Alternatively, Edith could elect to treat Archie’s IRA as her own IRA, or she could move the money from Archie’s IRA into Edith’s own IRA in her name.
  • Consequences of Choice: Edith’s election to rollover Archie’s IRA to her own IRA is usually the best option for a surviving spouse because the future RMDs will be calculated using the IRS’s Uniform Lifetime Table which will result in a smaller taxable RMD that Edith must take each year. A larger RMD will have to be taken each year if Edith decides to hold Archie’s IRA as an inherited IRA, because the IRS’s Single Lifetime Table applies to calculate Edith’s RMD each year.
  • Inaction: There is yet another option, of sorts, which is that Edith does nothing. Suppose that Edith does not take any remaining RMD distributions from Archie’s IRA. Nor does Edith make any affirmative election with regard to Archie’s IRA. In addition, Edith takes no steps to roll the balance of Archie’s IRA into Edith’s own IRA.  Edith, grief stricken by Archie’s death, is frozen into inaction, a situation which is not too hard to imagine.

Deemed Election: By being frozen into inaction, Edith will be deemed by the IRS to have elected to treat Archie’s IRA as her own IRA. That is the result because Edit permitted the year-of-death deadline to pass without having withdrawn the balance of Archie’s RMD for the year ($1,282.00) The IRS Regulations say that one way a surviving spouse can elect to treat a deceased spouse’s IRA as her own is to fail to take her husband’s full last RMD for the year. By her inaction, Edith has unintentionally elected to treat the IRA that she inherited from Archie as her own. That is all well and good, except some negative consequences can cascade from this deemed election that results from Edith’s inaction to take the balance of Archie’s RMD in the year of his death.

  • Larger RMD: Since Edith is also over age 70 ½, her RMD for the next year (after Archie’s death) will be calculated with regard to her own IRA plus the deemed elected Archie IRA that she inherited from Archie on his death. Both IRA balances will be used, on December 31, to calculate Edith’s next-year RMD from her two IRAs.
  • Possible Acceleration of Distributions: The deemed election causes Edith to be treated as the owner of Archie’s IRA. But Edith has done nothing with regard to the Archie IRA due to her inaction. Thus, there is a good chance Edith will not have completed a new beneficiary designation form for the Archie IRA that Edith is now deemed to own. If Edith dies in the year following Archie’s death, without affirmatively having named a beneficiary for the Archie IRA, the successor beneficiary will be her estate under many IRA custodial agreements. Under this scenario, since Edith was past her RMD age of 70 ½, and she failed to name a beneficiary for her Archie IRA, the distributions from the Archie IRA will be over the Applicable Distribution Period (ADP) that uses Edith’s life expectancy, rather than the life expectancy of the person who inherits the Archie IRA from Edith’s estate, probably her daughter Gloria, assume for the example age 56. Restated, the ADP for Edith, age 73 (a year after Archie’s death when Edith is one year older) will be 13.8 for the following year. Had Edith named Gloria as the designated beneficiary of the Archie IRA Edith is deemed to own, Gloria’s life expectancy, at age 56, could have been used to calculate Gloria’s RMDs from this inherited IRA. The result is that Gloria must take much larger RMD’s from the inherited Archie IRA; had Edith known that she was deemed to be the owner of the Archie IRA, she could have named her own beneficiary that resulted from the inherited Archie IRA.
  • Archie’s RMD of $1,282 : Suppose that Edith dies without having taken the balance of Archie’s RMD for the year of his death, i.e. the $1,282 that was not withdrawn from the Archie IRA prior to December 31 of the year of Archie’s death. That amount does not just disappear. If that is the case that Edith failed to take the balance of Archie’s RMD in the year of Archie’s death, on Edith’s death, Gloria will  have to take that amount ($1,282) and report it in her taxable income for the year. But because Edith failed to take the balance of Archie’s RMD for the year of his death, Gloria also gets to pay the 50% penalty. Gloria can ask the IRS to waive this penalty that arose, in effect, from the sudden deaths of both Archie and Edith.

Conclusion: The failure to take the balance of the decedent’s RMD in the year of the decedent’s death can cause a lot of problems for the surviving spouse and possibly the survivor’s beneficiaries, e.g. through a disclaimer by the survivor. While we are respectful of a surviving spouse’s grief, and we clearly want them to be able to grieve the loss of their spouse in their own time and manner, some affirmative action should be taken by the survivor if they are named as the deceased spouse’s IRA beneficiary to address the Regulation’s deemed election.