A lot of what I do as an estate planner involves helping people to have the most efficient (read: “inexpensive”) method of transferring their estates to their loved ones, or designated charities. One of the most inexpensive ways of transferring assets upon death is with a beneficiary designation. Life insurance, annuities and Individual Retirement Accounts (IRA) all have beneficiaries that must be named.
Who should be the beneficiary of my IRA?
The decision of whom to appoint as your IRA beneficiary is probably one of the most complex decisions facing the average estate planning client. There are various common choices: your spouse; your children; your Living Trust; or your favorite charity. Each of these choices has different and complex estate tax and income tax consequences.
Spouses are given definite tax advantages as beneficiaries of IRAs. The gift to the spouse qualifies for the estate tax marital deduction and your spouse is permitted to roll over the IRA into his or her own IRA and postpone distributions from the IRA until they reach 70½ years old. However, even with the obvious income tax advantages of naming a spouse directly, in second marriage situations, there are often over-riding reasons why the assets should go into a trust for the benefit of the surviving spouse.
Naming children as beneficiaries has some advantages, in that it is simple and straight-forward. However, if a child predeceases, the beneficiary designation form often does not provide for the exact same alternate takers as would be written into a person’s trust. For that reason, many times, clients want the IRA to go into their trust.
It is possible with careful drafting to have a trust as the named beneficiary of an IRA, and still have the ability to use the life expectancy of the beneficiary of the trust used when calculating the Required Minimum Distributions out of the IRA. However, without the proper language, naming a trust as beneficiary can result in being required to distribute the account balance within a short period of time, at a substantial income tax cost. A person should never name a trust as beneficiary unless they have consulted with their attorney and made sure that the trust contains the necessary language to avoid a bad income tax result.
For clients with taxable estates and charitable motives, serious consideration should be given to naming a charity as the beneficiary of their IRA. The gift to the charity qualifies for an estate tax deduction and, unlike a spouse or children, the charity will pay no income taxes upon the receipt of the IRA.