What's in a name? Well, if it's the name of your IRA beneficiary, it can be more than you think. Properly naming IRA beneficiaries is one of the most important, yet often overlooked, estate planning moves a person can make. If you don't choose a beneficiary, your probate judge will and your account may not be distributed as you had intended. If a beneficiary isn't named, the IRA goes to the estate and the distribution is based on your will or by state law if you die without a will. There are several reasons why your estate is the worst place for the IRA to end up.

If the IRA beneficiary is your estate, your account becomes subject to probate; the legal process of administrating and distributing one's estate. As part of the estate, the IRA is subjected to the claims of your creditors. Probate can be time consuming and costly; delaying and eroding the value of the asset for the final recipient.

Additionally, with your estate as beneficiary, a valuable opportunity to stretch the IRA over a longer period of time is lost for your final recipients. Let's go though the distribution rules if the estate is the beneficiary of the IRA. If the owner dies before starting their required minimum distributions (RMD) at age 70 1/2, the final recipient will need to withdraw all assets from the IRA by the end of the fifth year following the year of the owner's death. If the owner dies after starting their RMD, the recipient must take withdrawals based on the deceased owner's life expectancy.

Now if your beneficiary is an individual, they can stretch distributions over a potentially longer period of time to maximize the account's tax-deferred growth. A spouse can roll over the balance to their own IRA account and delay taking RMD until they turn 70 1/2. Non-spouse beneficiaries simply take the RMD based on their own life expectancy. The only exception for a non-spouse beneficiary is if the deceased had already started taking RMD and the beneficiary is older; in that case the beneficiary could use the deceased person's life expectancy to determine RMD.

Leaving the IRA to an individual can be particularly powerful when the beneficiary is much younger. For example, let's assume you name your 20 year-old grandson as your IRA beneficiary. Based on the IRS single life tables, your grandson would only need to withdraw slightly more than 1.7% of the account for the initial distribution year, gradually increasing throughout his lifetime. This is far superior to distributing the full account balance within five years.

If you have never named a beneficiary on your IRA account, you should designate one immediately. Of course, there are disadvantages to naming anyone as beneficiary. After the account holder dies, the beneficiary can do whatever he or she wishes with the money. This may mean taking the full balance of the account in spite of the account holder's plan for long-term, tax-deferred growth. The money could also find its way to the beneficiary's creditors, spouses, and ex-spouses. This makes choosing your beneficiary an important estate planning strategy.

Return To Index