Many investments permit you to name one or more beneficiaries. This is an important part of your estate planning as it can supersede what you specify in your will. It can affect tax calculations. And more. You can designate anyone or no one. If you designate no one, either your estate, state law or the contract you have with the financial institution will determine who receives your assets.
Common examples of beneficiaries include your spouse, your children, other individuals, a trust or a charity. However, designated beneficiaries can only be people. The reason for this is that a life-expectancy calculation is part of the IRA distribution process. (One important exception is that under certain circumstances, the oldest trust beneficiary can be treated as a designated beneficiary and control the distribution process.)
In this article, we’ll look at designating your spouse or your children as the beneficiaries of your IRA.
Let’s start with taxes. IRAs are included in the calculation of your estate taxes unless the beneficiary is your spouse. Spouses are entitled to inherit your entire estate tax free. Naturally this just defers the taxes until he or she dies at a later time. However, using the 2015 rates, his or her estate is also tax-free if it’s under $5.43 million. In terms of IRA distributions to the beneficiary, the normal rules apply. That is, ordinary income taxes are due when traditional IRA funds are withdrawn and no taxes are due for Roth IRA withdrawals.
Now let’s look at Required Minimum Distributions (RMDs). If your designated beneficiary is your spouse, they will normally roll your IRA into their IRA to protect these assets from creditors. (See Retirement Account Bankruptcy Protection for more information on this.) Further, if your spouse is more than ten years younger than you, naming him or her as the beneficiary can actually lower your required RMDs while you’re still alive. If you name your children as the beneficiaries, it’s important to know that the RMD will be based on the age of the oldest child. So, if you have children who differ in age significantly, it may be useful to create separate IRAs for each of them so that the RMD is calculated separately for each child.
For young children (or even for older children who may not be able to properly manage their money yet), a trust may be the best approach. When using a trust as a beneficiary, you must be careful how distributions are made in order to satisfy the RMD requirements of the IRS. Insufficient payouts can force distribution of the entire IRA within five years. You should talk with an estate attorney who is well versed with the IRS rules when naming a trust as the beneficiary of your IRA to ensure the proper language is used.
Naturally, your situation may be different. You may want to leave portions of your IRA to both your spouse and your children. These children may be the result of a previous marriage. You’ll want to be careful in the wording when naming children as beneficiaries so that it’s clear what should be done if one of them dies before you do.
The good news is that you don’t have to sort this out on your own. Guidepost Financial Planning and its estate-planning partners are able to help you with this aspect of your financial planning. Please visit our website or give us a call at 970.419.8212 so that we can discuss your financial goals in a no-charge, no-obligation initial meeting.
This article is for informational purposes only. This website does not provide tax or investment advice, nor is it an offer or solicitation of any kind to buy or sell any investment products. Please consult your tax or investment advisor for specific advice.