What are Separate Accounts?
Separate accounts (also referred to as the “separate account rule” or “separate share rule”) occur when there are multiple beneficiaries on a single IRA. This is very common. Often, IRA owners might name several children as beneficiaries on their IRA. But when more than one person inherits a single IRA, distribution complications arise.

The idea is to create separate accounts or shares by splitting the IRA into one for each beneficiary. The timing of the split, however, is critical to the long-term payout (the stretch IRA) for the beneficiaries. The IRA can be split by the IRA owner (during his lifetime) or by the beneficiaries (after the death of the IRA owner). The beneficiaries can never split an IRA while the IRA owner is still living. After all, it’s not theirs to split until the IRA owner has died.

The general rule under the regulations is that when there are several beneficiaries on one IRA, then post-death required minimum distributions (RMDs) are based on the beneficiary with the shortest life expectancy. When all beneficiaries are designated beneficiaries, this means you use the age of the oldest beneficiary.

In most cases it would be best that each beneficiary be able to use his or her own age for computing their RMD on the inherited IRA. This way if one beneficiary is 20 years old and another beneficiary is 50 years old, the 20-year old would not be forced to use the life expectancy of a 50-year old.

Separate accounts for each beneficiary can be created either before or after the death of the IRA owner. The best way to guarantee separate account treatment for RMD purposes (the ability of each co-beneficiary to use their own life expectancy to calculate post-death RMDs) is for the IRA owner to split the IRA into several IRAs naming one beneficiary on each IRA. Once that is done, there will be no question that separate accounts have been created and each beneficiary stands on his own for calculating life expectancy. The age of one child would have no effect on the other children (or other co-beneficiaries) for RMD purposes. This is the cleanest and certainly the most effective way to accomplish separate accounts for your IRA beneficiaries. It removes any problems later on as far as whether separate accounts have been created or have been created on time. The IRA owner does not have to worry whether this part of his estate plan will ever be taken care of since it was already done.

So why wouldn’t every IRA owner simply split the IRA and remove a potential problem? There are practical reasons why some IRA owners leave it up to their beneficiaries to do the split.

The most common reason why IRA owners don’t split their IRAs is convenience. It’s just easier to maintain one IRA with two or more beneficiaries than to maintain, say five or eight or ten separate IRAs. There is less paperwork and investments can be managed more easily. For example, if the IRA owner wants to leave her IRA equally to her three
children, it’s probably easier to have one IRA and name the three children as equal beneficiaries. This way, any appreciation or decline in the account’s value is automatically shared equally between the beneficiaries. If she had three separate accounts, the IRA that named child A as beneficiary may have increased in value while the other two IRAs have declined and you now have to rearrange the investments or transfer funds between IRAs to keep it all equal.

Another reason some IRA owners don’t split the account is cost. There may be fees for each account. This is a minor issue though compared to the big picture. It may be easier to keep fewer IRAs, but the tradeoff is that the beneficiaries may not timely split the IRA.

If the account is going to be split, check with the IRA custodian to be sure they will recognize different beneficiaries on the separate IRAs. There are some custodians that will only recognize the most recent beneficiary named as the beneficiary of all “like” IRAs an individual may have with that company.

If the IRA owner wants to guarantee the timely split, then she must split the account. The issues detailed below will show why the owner should split the IRA rather than leaving it up to the beneficiaries.

Spouse as Beneficiary
When a spouse is one of several IRA beneficiaries, the IRA owner should split the account and name the spouse as the sole beneficiary of the separate IRA. For example, if the IRA owner named his three children and his spouse as equal beneficiaries, the account should be split at least into two different IRAs. On one IRA, the spouse will be the sole beneficiary and on the other, the three children will be co-beneficiaries. It might also be advisable to split that one up into three separate IRAs, but if that is too cumbersome, at a minimum a spouse should not be named as a co-beneficiary on any IRA.

The tax rules provide spouse beneficiaries with several distribution advantages, but they are only available if the spouse is the sole beneficiary. If the spouse is not the sole beneficiary, that spouse (for distribution purposes) will be treated as a non-spouse beneficiary. This is why spouses should never be co-beneficiaries.

Spouse Beneficiary Advantages
The special rules below only apply if the spouse is the sole IRA beneficiary. However, even if the spouse is one of several IRA beneficiaries, the spouse can still qualify as a sole beneficiary if her share is split into a separate IRA by December 31st of the year following the year of the IRA owner’s death. The spouse is defined by federal law which, at this time, does not recognize same sex marriages.

Delayed Distributions
If the spouse is the sole beneficiary, and the IRA owner dies before his RBD, the spouse can delay required distributions until December 31st of the year the IRA owner would have turned 70½ years old, regardless of the age of the spouse.

Recalculate Life Expectancy
A spouse who is a sole beneficiary can recalculate life expectancy each year. She cannot do that if separate accounts are not set up.

Treat IRA as the Spouse’s Own
A spouse who is the sole beneficiary can treat the IRA as her own. She cannot do that if separate accounts are not set up.

Spousal Rollover
Only a spouse beneficiary can roll over her share of an IRA into her own IRA. There is no deadline for rolling over the spouse’s separate share. The spousal rollover, though, is best accomplished when the spouse is the sole beneficiary of a separate IRA as opposed to being one of several beneficiaries and having to split out her share after the IRA owner’s death.

Spousal Exception
If the spouse is the sole beneficiary for the entire year, and is more than 10 years younger than the IRA owner, then the IRA owner can base his lifetime required distributions on the joint life table instead of having to use the Uniform Distribution Table. If the spouse is not the sole beneficiary, the IRA owner must use the Uniform Distribution Table and distributions, and the resulting tax, will be larger.

Other Advantages to the IRA Owner Splitting the IRA

Family Problems
The split is guaranteed when done by the IRA owner. Each beneficiary will be entitled to stretch required distributions over his own life expectancy even if other beneficiaries choose not to. If the split is left for the beneficiaries, any post-death family problems or squabbles could delay, or worse, cause the IRA to not be split at all. In that case, the advantages of separate accounts will not be available. RMDs would be based on the age of the oldest beneficiary. If one of the co-beneficiaries is not a designated beneficiary (an estate, charity or trust) and separate accounts are not created, then there will be no designated beneficiary on the IRA and all beneficiaries will lose the stretch option. When separate accounts are set up, each beneficiary will control his or her own investment and
distribution options regardless of any problems between the beneficiaries.

Asset Allocation
When separate accounts are created by the IRA owner, he can allocate specific investments to the IRA for each beneficiary rather than leaving each beneficiary a certain percentage of the entire IRA.

Creating Separate Accounts After the IRA Owner Dies
Instead of splitting the IRA during his lifetime, the IRA owner could name his three children as equal beneficiaries of his IRA and leave it to the children to split up after his death. That is where the problems arise.

The regulations contain a provision that allows the IRA to be split after the death of the IRA owner, but there is still some confusion about the timing of the split. If the split (creating separate accounts) is not done timely by beneficiaries, then post-death RMDs will be based on the age of the oldest beneficiary or the beneficiary with the shortest life expectancy.

The identity of the designated beneficiary for calculating post-death RMDs is determined on September 30th of the year following the year of the IRA owner’s death. This creates some confusion that has still not been cleared up. It would seem that if the identity of the designated beneficiary is determined on the September 30th date, then the inherited IRA should be split by then. After all, there can only be one designated beneficiary (for calculating RMDs) on an IRA. There can be several beneficiaries named, but only one can be the designated beneficiary for RMD purposes. That designated beneficiary would be the one with the shortest life expectancy.

If at September 30th of the year following the year of the IRA owner’s death, there are still three beneficiaries on the IRA, then it would seem that the designated beneficiary would be the oldest or the one with the shortest life expectancy, or there would be no designated beneficiary if one of the three beneficiaries was an estate or a charity. An estate and a charity have no life expectancy and can never be designated beneficiaries.

The regulations, however, do not require the IRA to actually be split until December 31st of the year following the year of the IRA owner’s death. That’s plenty of time. Even if the IRA owner died on the last day of the year, the beneficiaries would still have until the end of the following year to split the account. This means that if you name your three children as co-beneficiaries on your IRA, they can each still be the designated
beneficiaries on their separate share if the account is split after the September 30th beneficiary designation date but before the end of the year.

For example, if the IRA owner dies in 2012, separate shares for RMD purposes can be created even if the account is split after September 30, 2013, as long as the IRA is split by December 31, 2013. Does this mean that the designated beneficiary can be determined as late as December 31st of the year following the year of death? No. The only explanation then, for the two dates is that September 30th is the date that the designated beneficiary is determined and December 31st is merely an administrative date by which the actual split must be done. To be safe, split by the September 30th date. That still gives your beneficiaries plenty of time.

Splitting After December 31st of year after IRA owner’s death is too late
If the account is not split by December 31st of the year following the year of the IRA owner’s death, then the separate accounts (for RMD purposes) can never be created, even if the account is split in a later year. All beneficiary RMDs will be based on the age of the oldest. If one of the beneficiaries is not a designated beneficiary, and the account is not split by December 31st of the year following the year of death, then the IRA will not have a designated beneficiary, even if the account is split later. The beneficiaries will follow the distribution rules that apply when an IRA owner dies without a designated beneficiary.

No Separate Accounts for Trusts!