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IRA Rules and Beneficiary Designations

You can’t take it with you, but you can control who gets it when you go.

Beneficiary designations are a crucial element of estate planning and, when done properly, can make things easier for your loved ones after you’re gone. If you name beneficiaries for your IRA, legal rights to your IRA assets will pass directly to your beneficiaries upon your death. If you don’t name a beneficiary, the terms of your IRA agreement will specify a default beneficiary, which is typically your spouse if you are married, and your estate if you are unmarried at the time of death. If your IRA assets pass to your estate, they will be subject to public proceedings in court called probate, which is the legal process of transferring ownership of assets after an individual’s death.

Probate assets will be transferred in accordance with your will. If you don’t have a will, ownership will transfer according to your state’s inheritance laws for individuals who die intestate (without a will). Although some people purposely name their estate as their IRA beneficiary for tax or other reasons, many IRA owners try to avoid probate for IRA assets because the process will take longer, cost more, and be more complicated for their heirs than inheriting the IRA assets directly.


Designating a Beneficiary

When you establish an IRA, you can name beneficiaries for the IRA right away by completing the form provided by your IRA custodian or completing the online account fields. You may name an individual as your beneficiary, or you may list a trust, charity, or your estate as beneficiary of your IRA. Certain states, however, have community or marital property laws that grant spouses special beneficiary rights. In these states, someone other than the spouse cannot be named as beneficiary unless the spouse has signed a waiver of their rights.

Provide complete information for your beneficiaries, including date of birth, address, and tax identification number. This will help your IRA custodian identify and possibly locate a beneficiary after your death. Then, remember to review your beneficiary designations periodically. This will help you keep their contact information current and help ensure your IRA assets are inherited by those you truly intend. Changes in circumstances such as a divorce or birth of a child often necessitate a change of IRA beneficiaries.


Primary vs. Contingent Beneficiaries


You may want to think about naming both primary and contingent beneficiaries. Primary beneficiaries still alive (or in existence in the case of a trust or charity) will be entitled to the IRA assets upon your death. Contingent beneficiaries will inherit the IRA assets only if the primary beneficiaries die before you or disclaim (i.e., relinquish) their interest in the IRA.

EXAMPLE: Kyle owns an IRA and has named his wife Karen as his primary beneficiary and his son, Kory, as his contingent beneficiary. If Kyle dies before depleting his IRA, Karen will inherit the remaining balance. As a contingent beneficiary, Kory will only inherit his father’s IRA assets if his mother dies before his father or if Karen disclaims her rights to the inherited IRA.

Per Stirpes vs. Per Capita Designations


You also have the option to name more than one primary beneficiary. If you do, it’s important to understand how the IRA assets will be disbursed if any of your primary beneficiaries precedes you in death. Your IRA custodian’s beneficiary designation form may include one or both of the following options:

  • Per Capita – The IRA assets will be divided among the surviving primary beneficiaries at the time of the IRA owner’s death.
  • Per Stirpes – The shares of the IRA assigned to a beneficiary who has predeceased the IRA owner will pass to that beneficiary’s children, grandchildren, or other lineal descendants upon the IRA owner’s death. (The descendants do not need to be individually named on the beneficiary form.)

While a per stirpes designation may better accomplish the IRA owner’s wishes in certain circumstances, it can be challenging for IRA custodians to determine who is a legal beneficiary and legal descendent of the IRA owner. Many custodians impose limits regarding the type of designations they will allow so they are not responsible for making legal determinations.


Beneficiary Distribution Options


Under the tax laws, different types of beneficiaries have different distribution options. The options depend on whether the beneficiary is a spouse, non-spouse individual, or entity such as a trust or charity; the age of the IRA owner at death; and who remains a beneficiary with an interest in the IRA as of September 30 of the year following the year of an IRA owner’s death.

The significance of a “designated” beneficiary as of the September 30 date has changed since the passage of the SECURE Act of 2019, which modified the distribution options for IRA beneficiaries. The distribution options available to “designated beneficiaries,” “eligible designated beneficiaries,” and “non-designated beneficiaries” will be the subject of future STRATA Trust blogs. In general, it’s important to know that a spouse beneficiary retains the broadest range of distribution options and the ability to keep the assets growing tax-deferred for as long as possible. An adult child or other person named as IRA beneficiary will, in most cases, be required to deplete the inherited IRA within 10 years of your death. These changes to the IRA beneficiary rules may affect who you name as your IRA beneficiary depending on your estate planning objectives.


Seek Professional Advice

Your beneficiary designation can have a significant impact on who will receive your IRA assets after you’re gone and when they will be taxed on those assets. Be sure to discuss your IRA beneficiary designations with your financial advisor, or a tax, estate planning or legal professional to maximize the benefits of your IRA for you and your beneficiaries.

 

Tags: beneficiaries, estate planning, IRA