Designated Beneficiary

What Is a Designated Beneficiary?

A designated beneficiary is a person who inherits an asset such as the balance of an individual retirement account (IRA) or life insurance policy after the death of the asset's owner. The Setting Every Community Up for Retirement Enhancement (SECURE) Act has narrowed the rules for designated beneficiaries when it comes to required withdrawals from inherited retirement accounts. The new rules apply to the beneficiaries of account owners who die after December 31, 2019.

Understanding the Designated Beneficiary

Under the SECURE Act, a designated beneficiary is someone named as a beneficiary on a retirement account and who does not fall into one of five categories of individuals classified as an eligible designated beneficiary. The designated beneficiary must be a living person. While estates, most trusts and charities can inherit retirement assets, they are considered to be a non designated beneficiary for the purposes of determining required withdrawals.

Please note, there are exceptions to the non-person entity rule for certain "see-through" trusts.

A designated beneficiary inherits the balance of an account, an annuity or a life insurance policy when the account owner passes away. Needless to say, anyone with a life insurance policy or other assets should review the documents regularly and make any changes required by new circumstances, such as marriage, birth, death, or divorce.

Multiple beneficiaries can be named. Assets can be divided among more than one primary beneficiary. There also can be more than one secondary beneficiary. The primary beneficiary or beneficiaries are the first in line to receive the asset. The secondary or contingent beneficiary is next in line if the primary beneficiary dies before the owner of the asset, cannot be located or refuses to accept the asset.

Designated beneficiaries may be revocable or irrevocable. If revocable, the owner of the asset can make changes. An irrevocable beneficiary has certain guaranteed rights that cannot be denied or amended.

SECURE Act and Designated Beneficiaries of Retirement Accounts

As a result of the SECURE Act, there are three groups of beneficiaries based on the recipient's relationship to the original account owner, their age, and whether they are an individual or non-person entity. The three categories are eligible designated beneficiaries, designated beneficiaries, and non-designated beneficiaries. The five categories of individuals considered to be eligible designated beneficiaries are:

1. The account owner's surviving spouse
2. A child who is younger than 18 years of age
3. A disabled individual
4. A chronically ill individual
5. A person not more than 10 years younger than the deceased IRA owner

If a living person who is named as a beneficiary of a retirement account does not fall into these five categories, they are considered to be a designated beneficiary.

10-Year Rule

Designated beneficiaries of inherited retirement accounts are subject to the 10-year rule. This means the remaining balance held by the inherited account must be withdrawn within 10 years following the account holder's death. There are no required minimum distributions (RMDs) for any given year, and recipients may choose the frequency and timing of withdrawals. However, the account must be fully depleted by Dec. 31 of the tenth year following the account holder's death.

This 10-year rule limits the time in which a beneficiary can benefit from tax-deferred growth. It ensures the retirement account's assets are withdrawn and therefore taxed within 10 years of the owner's death. Prior to the SECURE Act, retirement account holders were able to utilize an estate planning strategy referred to as the stretch IRA. The stretch IRA allowed the account to be passed down (potentially) for generations, as distributions were based on the life expectancy of the person taking withdrawals.

However, the 10-year rule does allow flexibility in when the distributions are taken. Because there is no required minimum distribution for any one year, a designated beneficiary can take withdrawals when it best suits their lifestyle and tax planning needs. For example, if Sue inherits a retirement account in 2020 and is subsequently laid off in 2021, it may benefit her to take a larger portion of the money out of the account in 2021 when she is in a lower tax bracket.

How to Collect

The designated beneficiary must make a claim to receive assets left to them as another person's designated beneficiary. The claim form will be supplied by the company that manages the asset. The form should 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.

Having a signed will in place is critically important. Otherwise, your designated beneficiary may face a long delay in getting life insurance or other assets.

State laws vary somewhat, but the company generally has up to 30 days to review the documentation and respond, either with an approval or with a request for additional information. Life insurance payments are normally paid out within 60 days of the filing of the claim.