Naming Your IRA Beneficiary – More Complicated Than You Might Expect

The decision concerning whom you wish to designate as the beneficiary of your traditional IRA is critically important. This decision affects the minimum amounts you must withdraw from the IRA when you reach age 70-1/2, who will get what remains in the account after your death, and how that IRA balance can be paid out. What's more, a periodic review of whom you've named as IRA beneficiaries is vital to ensure that your overall estate planning objectives will be achieved in light of changes in the performance of your IRAs and in your personal, financial, and family situation.

The issue of naming a trust as the beneficiary of an IRA comes up regularly. There is no tax advantage to naming a trust as the beneficiary of an IRA. Of course, there may be a non-tax related reason, such as controlling a beneficiary’s access to money; thus, naming a trust rather than an individual(s) as the beneficiary of an IRA could achieve that goal. However, that is not typically the case. Naming a trust as the beneficiary of an IRA eliminates the ability for multiple beneficiaries to maximize the opportunity to stretch the required minimum distributions (RMDs) over their individual life expectancies.

Distributions from traditional IRAs are always taxable whether paid to you or, upon your death, paid to your beneficiaries. Once you reach age 70-1/2, you are required to begin taking distributions from your IRA. If your spouse is your beneficiary, the spouse can delay distributions until the spouse reaches age 70-1/2 if he or she is under the age of 70-1/2 when inheriting the IRA. The rules are tougher for non-spousal beneficiaries, who generally must begin taking distributions based upon a complicated set of rules.

Since IRS distributions are taxable to beneficiaries, beneficiaries usually wish to spread the taxation over a number of years. However, the tax code limits the number of years based on whether the decedent had or had not begun his or her age 70-1/2 required minimum distributions at the time of their death.

If the decedent had begun taking his or her age 70-1/2 minimum required distributions the non-spousal beneficiaries must begin taking distributions in the first calendar year following the decedent’s death. Using the Single Life Table provided by the IRS, the post-death distribution period used to determine the RMD is the longer of: (1) the remaining life expectancy of the deceased IRA owner using the deceased’s attained age in the year of death and subtracting one for each subsequent year after the date of death or (2) the remaining life expectancy of the IRA beneficiary using the beneficiaries' attained age in the year of death and subtracting one for each subsequent year after the date of death. So as long as the beneficiary is younger than the decedent at the date of death, the IRA distributions can be stretched out over the beneficiary’s expected life.

If the decedent had not begun taking his or her age 70-1/2 minimum required distributions, the non-spousal beneficiaries must begin taking distributions in the first calendar year following the decedent’s death over the lifetime of the beneficiary using the Single Life Table. Where there are multiple beneficiaries, the life expectancy of the oldest beneficiary must be used.

In either case, whether the decedent had begun taking the minimum required distributions or not, the beneficiaries have the option to take the entire amount, in any manner desired, within the first five years after the decedent’s death.

To ensure that your IRA will pass to your chosen beneficiary or beneficiaries, be certain that the beneficiary form on file with the custodian of your IRA reflects your current wishes. These forms allow you to designate both primary and alternate individual beneficiaries. If there is no beneficiary form on file, the custodian’s default policy will dictate whether the IRA will go first to a living person or to your estate.

This is a simplified overview of the issues related to naming a beneficiary and the impact on post-death distributions. There are some less frequently encountered rules not covered here, and it may be appropriate to consult with our office regarding your particular circumstances before naming beneficiaries.