Clearing the AIR on IRAs (Part III)

For the third piece on IRAs, let's talk about beneficiaries.

Estate planning (the process of making sure your heirs get what you want them to get) is quite easily thrown off track in addressing retirement accounts/IRAs because these pass by beneficiary designations alone. Your wills and trusts have no control over your IRA accounts. No matter how much money you spend having them drafted.

In addition, IRAs aren't ever jointly owned (or owned by a trust during your lifetime), so you'll want the primary beneficiary to be your spouse if they'll be dependent on this money after your death.

And it doesn't even get complicated until after your death. The following are some common scenarios that come up after the death of an IRA account owner (of course, this isn't an attempt to document all scenarios):

For traditional IRAs

-Spouse beneficiaries can roll the IRA into their own account as if it were theirs all along. It's similar to a 401(K) rollover: there are no taxes or penalties to do so. There are also other options available to the inheriting spouse, but none minimize taxes in this same way.
-Non-spouse beneficiaries have a few options, but odds are that the least costly choice is to open an inherited IRA (which would be completely separate from their own IRAs) and begin annual required minimum distributions (similar to those discussed previously, but these start immediately). If this is the case, they'll likely need the help of a CPA or investment advisor to provide the calculation for the annual required distributions and assist in processing the withdrawal. The beneficiary is required to take a percentage of the account out each year (which is labeled as a taxable distribution) and pay the taxes on that income they received from the account.

For Roth IRAs

-Once again, spouse beneficiaries can roll the Roth IRA into their own without any taxes or penalties.
-Non-spouse beneficiaries are also required to take required minimum distributions annually, but this time the withdrawals from the Roth IRA are not taxable. It's merely a system designed to ensure assets aren't forever sheltered inside of Roth IRAs as they pass down to future generations.

In both cases

As you'll see in next week's post, things really start getting interesting for inherited IRA owners with all different sets of rules on required minimum distributions, deadlines, and adjusting the annual calculation.


A deeper dive on required minimum distributions.