Yet the logistics leaving IRA assets to loved ones, a trust, estate, or charity can get complicated; Morningstar.com contributor Natalie Choate, an IRA specialist, frequently writes about the mistakes people make when it comes to making IRA beneficiary designations.
Thus, before making plans for what will happen to your IRA when you're gone, be sure to understand the tax and other implications. Also double-check that your IRA beneficiary designations are in sync with any other estate-planning documents--trusts and wills--that you have drafted. Many people are surprised to learn that what's specified in the beneficiary designation will take precedence over what's specified in the other documents.
Here's what you need to know before leaving IRA assets to your spouse, other loved one, charity, estate, or trust.
If the Beneficiary Is Your Spouse
Spouses who inherit IRAs, unlike other people who might inherit IRA assets, have the opportunity to roll the IRA into an IRA in their own names. This is particularly beneficial if the spouse who inherits the IRA is significantly younger than age 70 1/2 and doesn't need the money; he or she will be able to delay required minimum distributions until then, because the RMDs are based on his or her own IRA assets, not the decedent's. (If the IRA assets are Roth rather than traditional, RMDs would not apply if the assets are rolled over into a Roth IRA in the spouse's own name.)
From a practical standpoint, most spouses who inherit IRAs are past RMD age, so this opportunity to delay withdrawals and preserve the tax savings of the IRA wrapper isn't that a big deal. In other words, if your spouse is near or at RMD age, your spouse definitely won't need your IRA assets during his or her lifetime, and another loved one like an adult child would benefit more from the money, there's not a strong tax case for leaving the money to your spouse.
If the Beneficiary Is a Child Or Another Loved One
Nonspouses who inherit IRAs can roll the money into an inherited IRA, thereby stretching out the tax-saving benefits over their own lifetimes if they choose to do so. Yet as Choate points out in this article
, very few people take advantage of this provision, either because they need the money imminently or because the individual was not named as a "designated beneficiary." If your goal is for a loved one to take advantage of this stretch provision, make sure that you've filled out the beneficiary designation form, not just named the person the beneficiary in your will. (You could check with your estate planner to be sure you've done it properly.) In addition, discuss your goals for a stretch IRA with your adult child or other loved one, to clarify this is what you expect him or her to do with the assets. Finally, it's worth noting that the future of the "stretch IRA" is in question, given that so few individuals take advantage of it.
While it might seem appealing to designate your young children or grandchildren as the beneficiaries of your IRA, bear in mind that minor children can't legally manage those accounts on their own. If you don't take pre-emptive steps to establish who will manage those assets prior to the child reaching the age of majority, the court will decide who will do it. If you'd like to make a child the beneficiary of an IRA, a better idea is to make the child the beneficiary, then specify in your will the name of a custodian to manage the child's financial affairs until he or she reaches a specific age. (The custodian can be the same person as the child's guardian, or it can be someone else.) Alternatively, you could make a trust the beneficiary of your IRA; your trust documents, in turn, can spell out how that money is to be managed and distributed to your heirs. (Below, I cover what happens when trusts are the beneficiaries of IRAs.)
If the Beneficiary Is a Charity
There are a couple of key tax benefits--not to mention emotional benefits--to leaving IRA assets to charity. Not only will the charity receive the assets tax-free, but your estate will also be eligible for a charitable deduction. By contrast, if you name children or other heirs as the beneficiary of the IRA, they'll pay taxes when they take withdrawals from the account, assuming it's a traditional IRA.
But while naming a charity (or charities) seems like it should be straightforward, complications can arise, as Choate details in this article
. One workaround is to name a donor-advised fund
the beneficiary of the IRA (or a portion of it); you'd then need to let the donor-advised fund sponsor know how you'd like the assets distributed to the charities of your own choosing.
If the Beneficiary Is Your Estate
This seems like the simple way out, but naming your estate as the beneficiary of your IRA--either via your will or on your beneficiary designation forms--is less desirable than naming an individual or charity. That's because those who inherit assets from your estate would be required to take distributions from the IRA account within a short period of time--either by the end of the fifth year following the account owner's death, if the deceased had not begun taking RMDs, or in line with the deceased person's own RMDs if he or she had already begun taking them. By contrast, if individuals are named as designated beneficiaries on your IRA forms, as discussed above, they'll have more flexibility to stretch out the tax-savings benefits.
If the Beneficiary Is a Trust
Making a trust the beneficiary of an IRA won't help your estate or your loved ones save on taxes; trusts usually entail extra costs and add complexity to an estate plan. You definitely don't want to make a trust the beneficiary of your IRA unless you have a valid reason to do so. A key rationale for making a trust the beneficiary of an IRA is if the individual you would like to benefit from those assets cannot manage the assets on his or her own. A minor child (discussed above) is a good example. Ditto for loved ones with special needs; not only is it possible that individuals with intellectual disability may not be able to manage the assets themselves, but inheriting assets outright could jeopardize eligibility for government resources that people with disabilities might otherwise be entitled to. Trusts can also be used to ensure that your loved ones take advantage of the "stretch" opportunity for the inherited IRA assets, rather than raiding the accounts all at once. Short answer: If you're considering making a trust the beneficiary of your IRA, get some estate-planning advice to ensure that it's really warranted.