Clients 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 the truth. Be sure to designate primary and contingent beneficiaries for all of 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 this.
- An IRA payable to an estate causes the IRA to be included in the assets distributed by the will. Since the cost to probate a will and the associated executor and attorney fees is generally a percentage of the will assets, this creates additional and unnecessary expense.
- An IRA payable to an estate 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 70 1/2) or during your remaining single-life expectancy if you die after your RBD. This is because an estate is not an individual with its own life expectancy, so no stretch over the estate’s life expectancy is permitted. While distributions are being made, the estate must be kept open, requiring a tax return every year.
- An estate is taxed more severely than an individual. For an estate, the top bracket (39%) applies to taxable income over $11,950 in 2013. For an individual (filing single) the top bracket (39.6%) applies to taxable income over $400,000. For an individual (married filing jointly) the top bracket (39.6%) applies to taxable income over $450,000.
- 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 70 ½.
- An IRA left to a non-spouse can be rolled into an inherited IRA, also extending the tax deferred or tax free growth. However, distributions will be required every year based on the beneficiary’s age.
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. Designate primary and contingent beneficiaries for all of your retirement accounts. Review the designations yearly and update as necessary.