Best Practices for Designating IRA Beneficiaries

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Question:  When my husband died I became the owner of his two IRA accounts.  They are now in my name and I take the required minimum distributions each year.  I also had two of my own IRA accounts so now I have a total of four.  I have my two adult children named as the beneficiaries, with a 50/50 split, on each account.  What is the best way to pass these IRAs on to my children? I would like my children to be able to keep the accounts as IRA accounts to avoid any immediate tax hit if possible, like I was able to do at the death of my husband.  Will the 50/50 split do this?  Or, would it be best to name each child as the sole beneficiary on separate IRAs?

Answer:  With four different accounts you have extra bookkeeping to do, extra investment management activities to perform, and extra steps to take each year when you calculate your required distribution.  There are easier ways, depending on what types of financial institutions you are using to maintain custody of the accounts and what your investment preferences are.

You can certainly simplify your situation and make it easier on you and on your beneficiaries.  You can combine the four IRA accounts into one account.  This single IRA account should be with a brokerage firm or mutual fund company that offers an ample choice of investments.  Ideally you will have access to a large selection of no-load mutual funds and exchange-traded funds.  This way you will have one IRA account in which you, or your financial advisor, can construct a well-diversified portfolio to meet your goals for growth, income, and risk management. 

You should make sure that your two children are designated as 50% beneficiaries.  If you want to have a child's share go to his or her children if a child predeceases you, you will want to make sure that the distributions are set up to be “per stirpes.”  Otherwise, if one child dies before you, the other child will get 100%.   The beneficiary forms that custodians provide don’t usually default to “per stirpes” so be sure to ask.

When you die your children will have until December 31st of the year after your death to split the account into two accounts.  Each beneficiary account will be titled as an IRA in your name for the benefit of one of your children, and each child will be able to use his or her own life expectancy to calculate the minimum required withdrawal each year.  This will provide a stretch-out of tax-deferral benefits and compound growth opportunities of your IRA over the lives of your children. 

Another choice, instead of combining all four of your IRA accounts into one, you could create two IRA accounts of equal value and name one child the beneficiary of one and the other child the beneficiary of the other.  To keep the account values equal, you could keep identical investments in each account.  This will mean less hassle (depending upon the custodian) for your kids when you die.  The end result would be the same.  Your two children would each have an IRA account that they can stretch out over their own lifetimes.

Kenneth B. Petersen CFP®, EA, MBA, AIFA® is an investment manager and Principal of Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey.   He welcomes questions that you may have concerning investing, taxes, retirement, or estate planning.  Send your questions to: Ken Petersen, 2340 Garden Road Suite 202, Monterey, CA  93940 or email them to ken@montereypw.com.