If you participate in an employer-sponsored retirement plan, contribute to an IRA, or roll over retirement plan assets into an IRA, you must designate a beneficiary or beneficiaries for each account. While these assets are included in your estate’s value for tax purposes, you cannot transfer ownership of a tax-deferred or tax-free account through a will or trust.
Your designated beneficiaries can align with those named to receive your other assets. However, with one important exception, they don’t have to be the same individuals.
The exception is that federal law requires you to name your spouse as the primary beneficiary of your qualified employer plan unless they sign a notarized waiver relinquishing their rights to the assets. However, this rule doesn’t apply to IRAs or annuities, even if the funds were rolled over from an employer-sponsored plan.
If you wish, you can also designate a qualified charitable organization or a trust you’ve established to receive some or all of your retirement plan assets.
Rolling it over
Among the primary reasons for rolling over employer plan assets to an IRA when you retire or leave your job is having greater flexibility in choosing beneficiaries and giving those beneficiaries more control over how they take money out of the account they inherit.
Getting started
Naming beneficiaries for retirement accounts is often simpler than setting up a will or trust, typically requiring just your signature. However, it’s important to carefully consider your goals. Be aware that some IRA providers require you to use their standard beneficiary designation forms and may not accept customized forms that reflect your preferred arrangements.
This is something to explore when selecting a provider — or a reason to consider switching providers as you update your estate plan. In most cases, you can name multiple beneficiaries for each account. To do so, you’ll assign a percentage of the assets to each beneficiary, as the exact dollar value of the account at the time of your death cannot be predicted.
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Keep in mind that if there are multiple beneficiaries, each person’s annual required minimum distribution (RMD) will be based on the age of the oldest beneficiary. One way to avoid this is by splitting a single IRA into separate IRAs, giving each beneficiary control over their own RMD schedule.
It’s also wise to name a contingent beneficiary for each account. This ensures that if your primary beneficiary passes away before fully withdrawing the assets, the remaining funds will go to someone you’ve designated, avoiding complications and keeping your wishes intact.
When things change
Regularly reviewing the beneficiaries you’ve designated for each account is crucial, ideally on an annual basis, or whenever you experience significant life changes such as marriage, divorce, the birth of a child, or the passing of a loved one. Failing to update your beneficiary designations can lead to complications and potentially prolong the distribution of your assets if there are legal disputes. Fortunately, you can change your beneficiaries at any time without incurring any costs. In many cases, some providers even allow you to make these updates conveniently online.
Deciding who gets what
You might opt to designate your spouse as the primary beneficiary of your retirement assets, as they enjoy significant flexibility in managing these funds, including the option to roll them over into an IRA in their own name. However, if your spouse has sufficient retirement savings, consider naming your children or even younger descendants, such as grandchildren or great-grandchildren, as beneficiaries. It’s wise to consult with your legal and tax advisers regarding the potential implications of the generation-skipping tax (GST), which could result in additional taxes if you leave assets to beneficiaries who are two or more generations younger than you.
One of the key benefits of designating younger beneficiaries, especially for IRAs, is the opportunity to extend the tax-deferred growth of your savings well beyond your lifetime. This strategy, often referred to as a “stretch IRA,” allows your heirs to maximize their tax-deferred earnings, enhancing their financial legacy over time.
Taking money out
Your beneficiaries will typically have the option to withdraw all the funds from your account by the end of the fifth year following your death or to take annual required minimum distributions (RMDs). The rules for calculating RMDs can vary based on the beneficiary’s relationship to you and whether you had begun taking distributions prior to your passing. Key factors in this calculation include the value of the inherited IRA at the end of the calendar year preceding the year in which the distribution is required, as well as life expectancy, which can depend on various circumstances.
To ensure your beneficiaries navigate this process smoothly, it’s advisable to inform them in advance to consult their tax or legal adviser. They should also review the relevant sections of IRS Publication 590, “Individual Retirement Arrangements (IRAs).”
If the inherited IRA is a traditional tax-deferred account, your beneficiary will owe taxes on the RMD, calculated at their ordinary income tax rate. Conversely, if it’s a Roth IRA, while RMDs are still required, they will be tax-free, providing an advantageous situation for your heirs.
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