Who Should Be Your IRA Beneficiary?

By Michael L Brunner

The only way to ensure that your IRA funds are passed along to whom you want in a tax-advantaged manner is to make sure that you put your intentions in writing with your IRA custodian.

You may have named an IRA beneficiary when you first opened the account. You should review this information periodically, especially when your personal circumstances change. On the other hand, if you do not name a beneficiary, the default beneficiaries spelled out in your IRA custodian's document will determine who will receive the assets. In some cases, these assets could go to your next of kin or even to an estranged spouse.

IRA beneficiaries are described generally as being a spouse or non-spouse. Your IRA beneficiary can be a person, a trust or a charity. Each designation has particular pros and cons that should be weighed in order to make sure your wishes are executed tax efficiently.

Spouses As Beneficiaries

Pro: Your surviving spouse can make a tax-free rollover of your IRA into an IRA in his/her name. Distributions from this account are taxed at your spouse's rate and any required minimum distributions are calculated based on the spouse's age.

Con: Leaving your IRA to your spouse may mean that your tax-free federal estate tax exclusion amount, up to $1 million in 2003, is not used. If you have substantial assets, you should speak to an estate tax professional who can offer suggestions on how to reduce or even eliminate the tax liability for your family's current and future generations.

Beneficiaries Other Than Spouses

Pro: If you leave your IRA to your children or grandchildren, your IRA may be given a second life that can provide your heirs with a lifelong stream of income. In addition, the inherited IRA could continue to grow tax-deferred for many additional years, if the transfer of assets is handled properly. All distributions are exempt from any 10 percent premature distribution penalty and in any given year, the non-spouse beneficiary is allowed to accelerate distributions without penalty.

Con: Non-spouse beneficiaries are not allowed to roll inherited IRAs into their own IRA. If the IRA is not passed along correctly, taxes may be due immediately. While your non-spouse beneficiaries have the opportunity to defer income taxes on your IRA for many years, any estate taxes must be paid in cash no later than nine months following your death. Minor children may not inherit an IRA until the age of majority. A trusted custodian must be designated for the child or the local probate court will appoint someone to handle the account for the child.

Trusts as Beneficiaries

Pro: Having a trust as a beneficiary ensures that the assets will be professionally managed according to your wishes. A trust may provide you and your heirs with asset protection from creditors.

Con: In most cases, designating your estate or your trust as a beneficiary entails the expense of professional asset management. Also, your beneficiaries may be locked into the terms of the trust and cannot manage the assets as they might choose.

Charities as Beneficiaries

Pro: Leaving IRA assets to a charitable beneficiary may be more tax-efficient than leaving the assets to a person since these assets are not subject to estate taxes.

Con: Assets left to a charity will be totally removed from your family.

Selecting the right beneficiary for your IRA can be complicated. Remember to look at your IRA assets in context with the rest of your estate before making any decisions You should discuss the subjects of beneficiaries, wills and other estate matters with your tax professional to be sure your decisions are appropriate for your situation.