Keeping your designated IRA beneficiary current is very important. You may not want your account going to your ex-spouse. And you definitely don’t want your chosen beneficiary to be someone who is deceased. Plus, the decision about whom you wish to designate as the beneficiary of your traditional IRA affects other items including:
- The minimum amounts you must withdraw from the IRA when you reach age 72;
- Who will get what remains in the account after your death; and
- How beneficiaries receive your IRA balance.
What’s more, a review of your named IRA beneficiaries will help ensure your overall estate planning objectives will be achieved. Especially due to changes in the performance of your IRAs and your personal, financial, and family situations.
For example, you named your spouse as your beneficiary upon opening an account several years ago. Since then, you’ve divorced. Your ex-spouse will remain the beneficiary of your IRA unless you notify your IRA custodian to change the beneficiary designation.
Naming a Trust As Your Beneficiary
The issue of naming a trust as the beneficiary of an IRA comes up regularly. There is no tax advantage to naming a trust as the IRA beneficiary. Of course, there may be a non-tax-related reason, such as controlling a beneficiary’s access to money; thus, naming a trust rather than an individual(s) as the beneficiary of an IRA could achieve that goal. However, that is not typically the case.
Generally, trusts are drafted so that IRA-required minimum distributions (RMDs) will pass through the trust directly to the individual trust beneficiary. Thus, RMD’s are taxed at the beneficiary’s income tax rate. However, if the trust does not permit distribution to the beneficiary, RMDs will be taxed at the trust level. The trust level has a tax rate of 37% on any taxable income in excess of $12,950 (2020 rate). This high tax rate applies at a much lower income level than for individuals.
Distributions from traditional IRAs are almost always taxable. However, a portion of a traditional IRA’s distributions will be nontaxable. This happens if some of the contributions to the IRA weren’t deducted on the IRA owner’s tax return when the contributions were made. But this situation isn’t very common.
Distribution Age When Your Beneficiary is your Spouse
Once you reach age 72, you must start taking distributions from your IRA. If your spouse is your designated IRA beneficiary, upon inheritance of your IRA, they can delay distributions until they reach age 72. That is, if your spouse is under age 72. The rules are tougher for non-spousal beneficiaries of individuals dying in 2020 or later. This is because the entire inherited IRA must be distributed to them (non spouses) by the end of the 10th year after the IRA owner’s death.
There are two exceptions to the 10-year distribution rule:
- A child (but not a grandchild) beneficiary of the deceased IRA owner will receive distributions based on life expectancy. However, the entire remaining balance of the IRA must be distributed within 10 years after the year the child reaches the age of majority. This is usually at 18 or 21 years old, depending on state law.
- For any individual, not more than 10 years younger than the deceased or who is disabled or chronically ill, the remaining account balance may be distributed over the life expectancy of the beneficiary. This is beginning in the year following the death of the deceased IRA owner.
Beneficiaries of IRA owners who died before 2020 can continue to take required withdrawals over their lifetimes.
How to Keep Your Designated IRA Beneficiary Current
You can ensure that your IRA will pass to your chosen beneficiary or beneficiaries by taking action. To start, be certain that the beneficiary form on file with the custodian of your IRA reflects your current wishes. These forms allow you to designate both primary and alternate individual beneficiaries. If there is no beneficiary form on file, the custodian’s default policy dictates where the IRA will go first. This is usually includes a living person, or to your estate.
These distribution rules, and the importance of keeping beneficiary designations up-to-date, also apply to employer retirement plans such as 401(k)s.
This is a simplified overview of the issues related to naming a beneficiary and the impact on post-death distributions. The bottom line is that Uncle Sam wants the tax paid on the distributions. And the rules pertaining to how and when beneficiaries must take taxable distributions can be very complicated.
It may be appropriate to consult with this office regarding your particular circumstances before naming beneficiaries.
Tax Consequences of Losing Your Job
