By Andy Ives, CFP®, AIF®
As Halloween approaches and the leaves change color, families gather ‘round weekend campfires, roast marshmallows, and share spooky stories. Watchful owls hoot in the dark. In the distance, a wolf howls at the moon. A rustle in the bushes. A twig snaps. What was that?!? A dad in a flannel shirt shines a flashlight under his chin, his features glowing red. He scans the anxious little faces, awash in flickering firelight, and tells a tale about the Ghost Rule.
Once upon a time, a kindly little man had an IRA account. He did not care much for tax or estate planning. He did not care to fill out forms, as he did not care much for details. He cared only to sit on his front porch and rock in his chair and watch the world go by. So, when his IRA custodian sent him a beneficiary form to complete, he paid it no mind. The kindly little man just sat in his chair and rocked and did what he enjoyed – watching the world drift along.
By-and-by, the kindly little man grew old, and he passed away.
It was up to the kindly little man’s only living heir, his son, to settle his father’s affairs. One item in need of attention was the IRA. The son wanted to establish an inherited IRA in his own name. He wanted the flexibility to spread distributions from the inherited account over 10 years as provided by the SECURE Act. However, he could not. The son was told by the IRA custodian that his father had never completed a beneficiary form. As such, the default beneficiary based on the custodian’s rules was the kindly little man’s estate. The custodian informed the son that an estate is a “non-designated beneficiary.” The custodian went on to say that, with a non-designated beneficiary, there are two payout options:
· If Death comes before the owner’s RBD (required beginning date) – generally April 1 after the year of the 72nd birthday – payments must be made under the dreaded 5-year rule. The account must be emptied by the end of the 5th year after death. This is the only time the terrifying 5-year payout rule reveals itself – when a person dies before his RBD with a non-designated beneficiary (like an estate).
· However, if Death takes his time and arrives on or after the RBD, payments must be made over the deceased IRA owner’s remaining single life expectancy, had he survived…the GHOST RULE!
The children around the campfire jolt upright and scream! Mom just rolls her eyes. She knows her husband is a lousy campfire storyteller, but she also knows his tale is true.
The “ghost rule” dictates that if death occurs after the RBD with a non-designated beneficiary (i.e., estate, charity, non-qualifying trust), then stretch payments are made to the non-designated beneficiary over the remaining single life expectancy of the deceased account owner, had he lived. RMDs apply annually under the ghost rule. Also, in a strange anomaly, the ghost rule payment schedule could be longer than the 10-year option. However, trying to orchestrate death under the ghost rule to take advantage of this extended payout as a planning strategy is discouraged.
If you want your retirement dollars to go to specific individuals, it is recommended you avoid the dreaded 5-year payout and ghost rule altogether. To sidestep probate and potential tax hassles, simply name your desired IRA beneficiaries directly on the beneficiary form.
Be sure to understand the payout rules applicable to your heirs. Death can be a real-life scary story. There is no reason to make the inheritance process any more unnerving.