4 Reasons Not to Name Your Estate as an IRA Beneficiary
Many people often assume that naming heirs in their will is sufficient and that there is no need to duplicate those beneficiaries in their IRAs or in their company retirement plans. This is far from true. Be sure to designate primary and contingent beneficiaries for all your retirement accounts using the proper paperwork provided by your custodian or plan administrator. Beneficiaries can certainly mirror your will if that is your intent. There are several compelling reasons for naming beneficiaries in your IRA.
1. Probate expenses
An IRA payable to an estate causes the IRA to be included in the assets distributed by the will, subjecting those assets to probate. Since the cost to probate a will and the associated executor and attorney fees are generally a percentage of the estate’s value, this creates additional and unnecessary expense and a certain delay in the distribution of those assets. Also, all probate details are a matter of public record. There is no privacy with probate.
2. Distributing the IRA
The Secure act passed in December of 2019 created three different categories of beneficiaries: Eligible Designated Beneficiaries, Designated Beneficiaries and those that are Non-Designated Beneficiaries. It has also modified the way IRA’s are handled after someone passes away post January 1, 2020. As of January 1, 2020 if your IRA is payable to an estate, a Non-Designated Beneficiary, it must be distributed within five years of your death if you die before your required beginning date (RBD — April 1 following the calendar year in which you reach age 72) or during your remaining single-life expectancy if you die after your RBD. While distributions are being made, the estate must also be kept open, requiring a tax return every year.
3. Estate income taxes
If distributions are made from the IRA while it is held by the estate, then these will be taxed at unfavorable estate tax brackets. For an estate, the top bracket (37%) applies to taxable income over $12,950 in2020. In contrast, for an individual (filing single) the top bracket (37%) applies to taxable income over $518,400. For a couple (married filing jointly) the top bracket (37%) applies to taxable income over $622,050.
4. Greater growth potential
An IRA left to a spouse can be rolled directly into the spouse’s own IRA, extending the tax deferred or tax-free growth, with no distributions required until the spouse reaches 72. An IRA left to a spouse also has creditor protection. IRA’s left to any other Eligible Designated Beneficiaries, must have their balances withdrawn over the longer of the beneficiary’s or the owner’s life expectancy. Eligible Designated Beneficiaries include, the owner’s spouse, the owner’s minor children (until they reach the age of majority), a disabled individual, a chronically ill individual, those not more than 10 years younger than the deceased and certain trusts. An IRA left to a Designated beneficiary can be rolled into an inherited IRA extending the tax deferred or tax-free growth. The inherited IRA will need to have all funds withdrawn within 10 years. Leaving an IRA to your spouse or child is a powerful way to help them plan for their retirement, but it should be done in the correct manner to minimize taxes. One of the few moments where naming your estate as your IRA beneficiary makes sense is if 100% of your estate is going to charity. Otherwise, it’s advisable to designate primary and contingent beneficiaries for all your retirement accounts. Review the designations yearly and update as necessary.