The 5-year rule only applies if the IRA owner dies before the required beginning date (RBD).
Applicability of the so-called “5-year rule” is one of the most misunderstood and error-prone areas of all the IRA distribution rules. That’s because many financial institutions still apply the 5-year rule. The 5-year rule mandates that the entire inherited IRA must be withdrawn by no later than the end of the year containing the IRA owner’s fifth anniversary of death.
Under the distribution regulations, the 5-year rule only applies when the IRA owner dies before his RBD with no living individuals as named beneficiaries (i.e., the beneficiary is a non-living entity such as a trust, charity or estate). In all other cases, the only way a beneficiary would be subject to the 5-year rule is if they elected it, or if the underlying IRA agreement required it. Realistically, it is highly unlikely that any beneficiary would either elect or be subject to the 5-year rule under the IRA distribution regulations.
A beneficiary named on the IRA beneficiary form is guaranteed the stretch IRA if they want it. They are permitted to extend (stretch) required distributions over their life expectancy as determined in the single life expectancy table.
Some of the confusion lies in the fact that under the old rules the 5-year rule was the default. You had to elect the stretch (e.g., life expectancy) option and most beneficiaries did not know to elect it. Now, the default is the stretch, so beneficiaries would only be subject to the 5-year rule if they elected it or the document still defaults to it.
If there is no designated beneficiary and the IRA owner dies after his RBD, the 5-year rule still does not apply because the 5-year rule never applies when the IRA owner dies after his RBD. In this case, the inherited IRA would be paid out over the deceased IRA owner’s remaining single life expectancy as determined in the year of death.
If you are a beneficiary, be on guard if anyone tells you that your inherited IRA must be withdrawn in five years. That is unlikely.
6 Year Rule – Due to suspension of RMDs for 2009
For some beneficiaries, the 5-year rule has become a 6-year payout. If an individual was a beneficiary in 2009 using the 5-year rule, they will have an extra year to empty the account. This only applied to beneficiaries who inherited in 2004-2008 and is due to the suspension of RMDs in 2009.
Now, in 2013, only 2007 and 2008 beneficiaries are still affected. 2007 beneficiaries using the 5-year rule must distribute the balance of their inherited funds by the end of this year (2013) and 2008 beneficiaries must distribute the balance of their inherited funds by the end of 2014.