IRA Designations

For many people, IRAs are the major assets of their estate. Yet many of my clients are unsure how to protect this asset for the benefit of their families.

Check Your IRA IQ:

Are IRAs automatically part of your will or trust?

The answer is no. IRAs do not pass through your will or trust. You need to complete a beneficiary designation form with each institution that holds an IRA for you.

What happens to your IRA if you have not chosen a beneficiary?

You do not have to choose a beneficiary, but if you don’t, the courts will choose it for you through the probate process. If you neglect to name an IRA beneficiary or your beneficiaries cannot locate your IRA beneficiary form, then your IRA will most likely pass to your estate and go through probate. If you name “estate” on your beneficiary designation, it will pass through probate.

If you have wills, you should make sure that you name a beneficiary on your beneficiary designation form.

I have a living trust. Shouldn’t I list the trust as IRA beneficiary?

Surprisingly, you probably should not name your living trust as the beneficiary of your retirement assets. If your trust does not have a qualifying IRA trust (see below), the IRS will require distributions within 5 years. The tax implications can be significant. Because the IRS has special rules regarding retirement assets, you need to consider carefully who should be the beneficiary. A general rule of thumb is that you should title all assets in your trust (called “funding” the trust) except retirement plans.

What are my options for naming a beneficiary if I have a living trust?

If You’re Married, then Spouse:

If you name your spouse as the beneficiary, your spouse has the power to roll over the retirement asset. This means that the spouse can roll over the inherited retirement asset into the spouse’s account and let it grow until the spouse reaches 70, the mandatory age when the spouse needs to take out minimum distributions. (If you would like to make sure that your IRA is in a trust on behalf of your spouse, you need to make sure that the trust is a qualifying IRA trust – see below.)

Other IRA Beneficiary Options:

  1. A living trust with a qualifying IRA trust
    If your trust does not have a qualifying IRA trust, the IRS will require distributions within 5 years. Because retirement assets are taxed when distributions are taken, your beneficiary may have a heavy income tax burden when distributions are made. It also will prevent the IRA asset from future growth.
    A qualifying IRA trust (such as a conduit trust) will require your beneficiary to stretch out the IRA over the beneficiary’s lifetime. So, if your beneficiary wanted to take the retirement assets in a lump sum, the beneficiary couldn’t without a court order. Some owners of IRAs desire this for the income tax benefits to the beneficiary and for the extra measure of control.
  2. Name individual beneficiaries
    When you name individuals, you are giving the choice to your beneficiary as to whether to take out the retirement asset in a lump sum or to stretch out over their lifetime. If they are minors, the guardian of the estate can make the decision to stretch it out (or not). Once the minors reach majority age, they can decide what to do. Owners of IRAs can ask in the Letter of Wishes that the minors stretch out the IRA over their lifetime. However, be aware that the money could also be available to the beneficiary’s creditors, spouses and ex-spouse(s). And there is the risk of court involvement at incapacity.
  3. Designate a Charity
    Naming a charity or charities as beneficiaries is a great choice. The charity is exempt from income taxes on the distributions and your estate is reduced by the charitable gift for estate tax purposes.

I hope this post has boosted your IRA IQ, but it is clearly not a “one size fits all” issue. IRA designations warrant a conversation with your estate planning attorney and possibly your financial advisor. With the value of your IRAs often in excess of $250,000, it is a very worthwhile conversation to have.