Wealth Building Lessons

You have a few different choices when it comes to naming your IRA’s beneficiary. The worst thing is not to name anyone. In that case, the IRA is divided according your your will. If you don’t have one, then each state has its own rules for distributing your assets and I’m pretty sure you won’t like any of them. Least of all, paying the high probate attorney fees and court costs!

If you don’t name a beneficiary, the proceeds of your IRA must be distributed within 5 years. However, by naming a beneficiary you can extend that over the life span of the beneficiary.

Naming your estate as the beneficiary is the same as not naming one. The rules require a “named” beneficiary. Now your IRA goes through the probate process. This costs money, takes time and subjects your IRA to your creditors.

You will have to pay a probate attorney and court fees to get some judge decide whom your beneficiary will be. Your beneficiaries will have to sit around waiting for your estate to be closed. If your will is challenged, it will lengthen this process. If you have a large estate and IRS questions the valuation of your business or holdings, it might be years before the issue is settled. And in the worst case, your IRA might be completely eaten up by legal fees.

Most people name their spouse as a beneficiary and it usually makes sense.

If the spouse is the sole beneficiary, he or she can elect to treat the IRA as his or her own. This opens up the possibility of delaying the start of the required minimum distributions (RMDs). This could be the spouse’s age 70 1/2, or for a Roth IRA, all the way to the death of the spouse. It also allows further “stretching” of the IRA as the spouse can spread the RMDs over their lifetime plus the lifetime of a beneficiary.

If the spouse is more than 10 years younger than a non-Roth IRA owner, their life expectancy can be used. Beneficiaries other than the spouse, who are more than ten years younger than the IRA owner, are treated as being no more than ten years younger for RMD purposes.

If children are beneficiaries, they can take the RMDs over their life expectancy. Since the RMDs are very low at the younger ages, the account can grow substantially over the years. A $100,000 IRA could distribute millions of dollars over the lifetime of a young beneficiary.

Because grandchildren are even younger than children are, the lifetime income potential from RMDs is astounding. The same $100,000 IRA used above as an example could pay out 20 million dollars to a grandchild over their lifetime under the right circumstances.

Naming a grandchild gets into the generation skipping transfer tax area. But each person has a lifetime generation-skipping transfer tax lifetime exemption of $2,000,000 (in 2006). If you doing this, you might want to consult a financial planner or an estate planning attorney to make sure its done correctly.

Sometimes it makes sense to name a trust as the beneficiary of your IRA. Your estate could be large enough so that you do not want your IRA to be subject to taxation twice. You may want to take advantage of the marital deduction, control where the balance of your IRA goes after the death of your spouse or have a spouse that is not a U.S. citizen.

Regardless, of who you name, you might want to consult an estate planner to ensure you make the best possible choice.

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