Selecting IRA Beneficiaries

Question:  I am a widow and I have three adult children who are beneficiaries of my IRA account.  I will be taking my first required minimum distribution next month.  What happens to my IRA when I die, and what pitfalls should I be aware of ?

Answer:  Even though the tax rules about IRA’s seem to be simple, the IRA distribution road is full of potholes.  There is as much need for planning now as there has ever been if you want things to happen the way you would prefer that they happen.  If there are no complications, chances are when you die your three children will be able to split up your IRA and either take their share and pay the income tax immediately or create a new “inherited” IRA account in your name for their benefit.  For example, if each child wanted to stretch out the tax-deferred growth that an IRA can offer for as long as possible, then they could split your account into three separate inherited IRA accounts.  Your children, as beneficiaries of your IRA, could then begin to take minimum distributions based upon their own life expectancy.  Your children in turn can name their own beneficiary on your IRA while they are taking minimum distributions so that when your child dies, the new beneficiary can continue to take your child’s distributions.  (Be aware that for inherited IRA accounts, some IRA custodians may require you to name your estate as your beneficiary.)

But what if there are complications?  For example what happens if one of your three children dies before you do?  Would you prefer that his children (your grandchildren) get his share, or would you rather see your IRA split between your two surviving children, leaving your grandchildren without any part of the IRA?  If you simply filled out the beneficiary designation on your IRA application with your three children listed as primary beneficiaries, then your IRA will probably be distributed to the two surviving children and your grandchildren will be inadvertently disinherited.  The reason is that most beneficiary forms don’t allow you to select whether your assets should be distributed per capita or by right of representation.

Another complication could occur if one of your children should die after you but before December 31st of the year after your death- the date on which the designated beneficiary is determined.  In that case, it is possible that that child’s estate will get the money but lose the income tax stretch-out feature, meaning that the estate would have to pay tax sooner than they might want to. 

Because of these uncertainties, one option to consider is to split your IRA account into three equal but separate IRA accounts, one for each child.  On each account, you can name one of your children as primary beneficiary and his children – your grandchildren – as contingent beneficiaries.  This may make it a little more complicated for you, but it might make the distributions upon your death simpler and in line with your intentions. Proper planning can ensure your family legacy will survive for as long as possible.  You should review your IRA beneficiary forms with your estate-planning attorney to be sure they conform to your wishes.

 

 

Kenneth B. Petersen CFP®, EA, MBA, AIFA® is an investment advisor 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, CA93940 or email them to ken@montereypw.com.