What is a designated beneficiary?
A designated beneficiary is a person who has been designated to inherit an asset such as the balance of a individual retirement account (IRA), an annuity, or a life insurance policy after the death of the asset owner. He is also known as a designated beneficiary.
The Every Community Establishment for Retirement Enhancement Act (SECURE) tightened the rules for named beneficiaries regarding required withdrawals from legacy retirement accounts. The new rules apply to beneficiaries of account holders who died after December 31, 2019.
Key points to remember
- A designated beneficiary is named on a life insurance policy or financial account as the recipient of those assets in the event of the account holder’s death.
- A designated beneficiary is a living person. Non-person entities are not considered designated beneficiaries, even if named on a retirement account.
- A designated beneficiary is also not one of the five categories of eligible designated beneficiaries as defined by the SECURE law.
- The named beneficiary usually must file a request with a copy of the death certificate to receive the assets.
Understanding the designated beneficiary
Under the SECURE law, a designated beneficiary is a person designated as the beneficiary of a retirement account and who does not belong to one of the five categories of persons classified as eligible designated beneficiary (EDB). The designated beneficiary must be a living person. Although estates, most trusts and charities can inherit retirement assets, they are considered unnamed beneficiaries for tax purposes and for determining required withdrawals.
A designated beneficiary inherits the balance of an account, annuity, or life insurance policy when the account holder dies. Needless to say, anyone with a life insurance policy or other assets should regularly review the documents and make any changes required by new circumstances, such as marriage, birth, death, or divorce.
Multiple beneficiaries can be named. Assets can be split between several main beneficiary. There may also be more than one secondary beneficiary. The primary beneficiary or beneficiaries are the first to receive the asset. The secondary or contingent beneficiary is next in line if the primary beneficiary predeceases the asset owner, cannot be located, or refuses to accept the asset.
Designated beneficiaries can be revocable or irrevocable. Whether revocable, the asset owner can make changes. A irrevocable beneficiary has certain guaranteed rights which cannot be denied or modified.
SECURE Act and Designated Beneficiaries of Retirement Accounts
Due to the SECURE law, there are three groups of beneficiaries depending on the beneficiary’s relationship with the original account holder, their age and whether they are a natural or legal person. The three categories are Eligible Designated Beneficiaries, Designated Beneficiaries and Undesignated Beneficiaries. The five categories of people considered eligible designated beneficiaries are:
- The surviving spouse of the account holder
- A child under 18
- A disabled person
- A person with a chronic illness
- A person less than 10 years younger than the deceased IRA owner
If a living person designated as the beneficiary of a retirement account does not fall into these five categories, they are considered a designated beneficiary.
10 year rule
Designated beneficiaries of legacy retirement accounts are subject to the 10-year rule. This means that the remaining balance held by the inherited account must be withdrawn within 10 years of the death of the account holder. There’s no Required Minimum Distributions (RMD) for a given year, and beneficiaries can choose the frequency and timing of withdrawals. However, the account must be fully depleted no later than December 31 of the tenth year following the death of the account holder.
This 10-year rule limits the length of time a beneficiary can benefit from tax-deferred growth. It ensures that assets in the retirement account are withdrawn and therefore taxed within 10 years of the owner’s death. Prior to the SECURE Act, retirement account holders could use an estate planning strategy called stretch ira. The Extended IRA allowed the account to be passed on (potentially) for generations, as distributions were based on the life expectancy of the person taking withdrawals.
However, the 10-year rule allows some flexibility as to when distributions are taken. Because there is no minimum distribution required for a year, a designated beneficiary can make withdrawals when it best suits their lifestyle and tax planning needs.
The exceptions to the 10-year rule concern certain types of beneficiaries:
- a surviving spouse
- a disabled or chronically ill person
- a child who has not reached the age of majority
- a person less than 10 years younger than the IRA account holder
These beneficiaries are not obligated to empty the IRA. But unless they can treat the account as their own (see “Special rules for surviving spouses” below), they must withdraw annual RMDs from it; the exact amount can be calculated based on their own life expectancy.
The SECURE Act distinguishes between an eligible designated beneficiary and other beneficiaries who inherit an account or IRA. Designated beneficiaries, who are not eligible designated beneficiaries, must withdraw the entire IRA no later than the 10th calendar year following the year the employee or IRA owner died after 2019. Beneficiaries non-designated must withdraw the entire account within 5 years of the death of the employee or IRA owner if distributions did not begin before death.
How to collect
The designated beneficiary must make a claim to receive property bequeathed to them as a designated beneficiary from another person. The complaint form will be provided by the company managing the property. The form must be returned with a copy of the account holder’s death certificate. This is available from the county or state in which the person lived.
State laws vary somewhat, but the company generally has 30 days to review the documentation and respond, either with an approval or a request for additional information. Life insurance payments are normally made within 60 days of the filing of the claim.
Having a signed will in place is critically important. Otherwise, your designated beneficiary may face a long delay in obtaining life insurance or other assets.
What makes a beneficiary designated?
A beneficiary is a person or entity that receives part of an inherited estate. A designated beneficiary refers to a specific person or entity that was named and documented by the estate owner prior to their death.
Who can inherit qualified retirement accounts like IRAs?
If a person dies with a qualified retirement account like an IRA or 401(k), only an eligible designated beneficiary (EDB), as defined by law, can take possession of it. This must be a person who is usually the surviving spouse, an adult child, or a disabled or chronically ill person who can benefit from the funds.
Who can be an eligible designated beneficiary (EDB)?
An eligible designated beneficiary (EDB) must be an individual, not a non-person entity such as a trust, estate, or charity (which would not be designated beneficiaries).
There are five categories of individuals included in the EDB classification:
- Owner’s surviving spouse
- The owner’s child under the age of 18
- A disabled person
- A person with a chronic illness
- Any other person who is no more than 10 years younger than the deceased IRA owner
In most cases, except for the exceptions below, an EDB must withdraw the inherited IRA account balance over the life expectancy of the beneficiary.
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