Choosing an IRA Beneficiary? Choose Wisely…

Key Takeaways

  • Your choice of beneficiary(s) for your IRA can have major tax consequences. Choose wisely with your advisor’s counsel.
  • Leaving your IRA to an individual is a simple and flexible solution.
  • Leaving your IRA to a trust is more complex and requires the advice of an experienced estate attorney.

How do I choose the right beneficiary for my IRA? That can be a bit of a trick question. Choosing a beneficiary(s) for your IRA is a very personal decision. For a variety of reasons, I can’t tell you–nor would you want me to tell you–who should receive one of your largest assets after you pass away. As I wrote in a previous blog Is My Will Enough?, your beneficiary designation is an essential part of your total estate plan that includes your will, your durable power of attorney and your healthcare power of attorney.

Most people leave their IRAs to their spouse or their children. Generally, this strategy works very well because the beneficiary of the IRA has three options for withdrawing funds from the IRA once they receive them. The IRS requires the beneficiary to either:  1) Withdraw the entire IRA balance within one year of the owner’s death, 2) Withdraw the entire IRA balance within five years of the owner’s death or 3) Withdraw the funds over their own lifetime.

Whichever withdrawal method is used, it’s important to note that distributions from the IRA are taxable to the beneficiary. If the IRA is distributed within one year or within five years (see Options 1 and 2 above), the taxes will generally be much higher than if distributions are withdrawn in smaller amounts over the beneficiary’s  lifetime. Keep in mind, that if option 3 is chosen (see above), the beneficiary can always take more funds out of the IRA.  Leaving your IRA to your estate is often the least favorable option. That’s because the account must be distributed and taxed at the time of the owner’s death.

Leaving an IRA to an individual person has the advantage of allowing the required distributions from the IRA to be “stretched” over the beneficiary’s lifetime and thereby reducing their taxes. But suppose you wanted to leave your IRA to a trust or to a trust created in your will? Would you have more control over the disposition of those assets?

Ryan Bornstein, J.D., LL.M, a tax and estate attorney and Villanova University law professor told me the answer is “Yes,” but that it gets much more complicated under this scenario. “Special language must be included in the trust, or in the will to preserve the ability of the ultimate beneficiary to stretch the distributions over their lifetime,” explained Bornstein. He also told me that unfortunately, he sees many trust documents written by other attorneys that do not have this “stretch-specific” language which could result in very unfavorable tax treatment for the beneficiary. Ouch! 

Conclusion

Proper beneficiary planning is a key component of your overall estate plan and financial plan. A good wealth manager will have a solid foundation in tax, retirement and estate planning and will have access to highly experienced estate attorneys available to assist on highly complex matters.

If you suspect that a close friend or family member needs help with retirement, tax, estate planning or other wealth planning matters, please don’t hesitate to contact us or refer them to us (610.695.8070). We’d be happy to help.

 

Ryan Bornstein, J.D., LL.M (Taxation) is a partner at the law firm of Harvey Ballard & Bornstein, LLC located in Berwyn, Pennsylvania. Mr. Bornstein is a Professor of Law with the Adjunct Faculty of the Graduate Tax Program at the Villanova University School of Law, a Professor in the Accounting Program at the Villanova University School of Business and a Professor in the Paralegal Program at the Villanova University Continuing Studies Department. Mr. Bornstein has taught Introduction of Taxation, Legal Orientation, and Taxation of Property Dispositions in the Graduate Tax Program. Currently, Mr. Bornstein teaches Tax II in the Graduate Tax Program as well as Federal Income Tax and Advanced Taxes in the Villanova University School of Business, and Trusts and Estates in the Paralegal Program. Recently, Mr. Bornstein created the Tax II course for the online Villanova Graduate Tax Program.

 

 

 

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About Mark Rioboli

Mark A. Rioboli, CFP®, CFS is Director of Wealth Management for Independence Advisors, bringing over 25 years of experience in the wealth management industry. Have a question for Mark? CLICK HERE TO ASK MARK

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