Considerations When Designating The Beneficiary Of Your IRA

As more and more workers are saving for retirement through IRA’s and 401(k)s, the question that usually comes up is who should be named as beneficiary.  Who you name as beneficiary and how your pre-tax account is transferred could have significant tax consequences.

  • Spouse As Beneficiary

The simplest yet optimal way to to pass your IRA is to name your spouse as beneficiary.  Your surviving spouse will have four (4) options at your death:

  1. Roll over the assets into a new or existing IRA
  2. Transfer the assets to an inherited IRA
  3. Convert the assets to a Roth IRA
  4. Disclaim all or part of the assets

For purposes of this article, we will only discuss these options generally, and will not go into detail regarding the advantages/disadvantages to these four options.  As you can see, the surviving spouse has several options to choose from.  He or she can use the funds if there is an immediate need, allow the assets to compound tax-deferred for future retirement needs, or disclaim to other beneficiaries for tax benefits.

  • Children, Family, Others As Beneficiary

Naming children, grandchildren or other family members may be a simple way to transfer your IRA, but it is also fraught with danger.  If your beneficiaries have no currrent or pending “issues”, it may make sense to name them as beneficiaries through the custodian/company that manages your account.  If your potential beneficiaries do have “issues”, such as a substance abuse problem, gambling addiction, spendthrift issues, a pending divorce or bankruptcy or other liability issues with creditors, you may want to consider distributing your IRA through a trust. Another issue of naming a beneficiary outright is that you will lose control on how the account is used after death.  The beneficiary has the right to liquidate the entire account upon your death if they choose.  A trust should be considered to ensure your legacy is preserved and distributed to your beneficiaries as you wish.

  • Trust As Beneficiary

Naming a trust will give you the most control over your IRA upon your death.  Your assets, instead of being distributed directly to your beneficiary will be paid to the trustee of your trust  to be distributed according to the terms of your trust.  Trusts for this purpose must be carefully drafted, so please consult with an experienced estate planning attorney to discuss this type of planning.

These are not the only estate planning options when transferring an IRA to beneficiaries, but are the most common for purposes for this discussion.