Estate Planning
Leave an IRA That's Heir-Tight
Follow complex rules and avoid common mistakes when leaving your retirement account to your beneficiaries.
By Kathryn A. Walson, Staff Writer, Kiplinger's Retirement Report
March 3, 2009
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EDITOR'S NOTE: This article was originally published in the December 2008 issue of Kiplinger's Retirement Report. To subscribe, click here.
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The turbulent stock market may have taken a toll on your IRA. Still, there's a good chance that your retirement account holds the lion's share of your savings.
You probably want your assets in the tax-deferred account to last long after you die. If your children or other heirs take required minimum distributions based on their life expectancies, perhaps they can stretch the money well into retirement. Maybe even your grandkids could benefit.
But a slip-up could unravel your fine intentions. You could end up leaving your IRA assets to your Uncle Louie, while your spouse and kids are left out in the cold. Or your IRA custodian could blow the stretch opportunity for your children by liquidating the account after your death.
With adequate planning, you can avoid mistakes that could jeopardize the legacy you want to leave. IRA rules are complex, so consult with an estate-planning lawyer.
The first step is to designate a beneficiary, or several beneficiaries, on the IRA forms. Make sure you and your lawyer keep copies of the documents. "People think that if they set up a beneficiary, the banks will have it on file," says Ed Slott, author of Your Complete Retirement Planning Road Map (Ballantine, $26). "With all these bailouts and market problems, odds are your beneficiary paperwork is not their top priority."
Also, update your designation forms after major life events, such as deaths, births and marriages. "You want to be sure that the people you want to inherit these assets ultimately receive them," says Jeremy Welther, a certified financial planner with Brinton Eaton Wealth Advisors, in Madison, N.J.
Catherine Schmidt, an estate-planning lawyer with Patterson Belknap Webb & Tyler, in New York City, says an account holder should reconsider designations if the IRA has grown dramatically over time. Say someone planned years ago to leave most assets to her children from her first marriage, with some money going to her current husband. Back then, her IRA made up 20% of her total assets, so she named her spouse as the beneficiary, leaving the other 80% to her kids.
"But after a number of years, the IRA could make up 50% of total assets," Schmidt says. The account holder could then decide to leave a portion of the IRA to the husband and a portion to the kids.
Such a review is particularly important in light of the current economic crisis when your portfolio has likely lost money. Say you specified that $200,000 of your $1 million IRA should go to charity, with the balance going to your child. If your IRA drops in value to $700,000, the charity would still get the promised $200,000, but your child's share would fall to $500,000.
Make sure to also name contingent beneficiaries, who will inherit the IRA if the primary beneficiary dies before the IRA owner. For example, if you named your wife as the primary beneficiary and your daughter as the contingent beneficiary, your daughter will inherit the assets if you and your wife die.
If you name several beneficiaries, you'll need to decide what happens to each beneficiary's share if one dies before you. Say your son and daughter are equal-share beneficiaries. The son has children, and he dies before you. His share could end up going to your daughter, rather than to your son's kids, unless you instruct a per stirpes, or line of descent, distribution.
What if you don't designate a beneficiary on the IRA forms, or what if you name your estate as your beneficiary? The account will likely go through probate, a process aimed at determining the heirs of an estate. Most important, by failing to designate a person on the IRA documents, your heirs can't take distributions based on their life expectancies.
In that situation, how fast heirs must take distributions depends on whether you've begun taking required minimum distributions. If you die before 70 1/2, your heirs must withdraw all of the money within five years after you die. If you die after age 70 1/2, your heirs must take payouts based on your remaining life expectancy, not their longer ones (visit www.irs.gov for life-expectancy tables).
Reader Comments (3)
Posted by: f hund at 03/03/2009 08:39:35 PM
Please comment on treatment of Roth IRA's in estate. What are tax consequences for heirs?
Posted by: hank at 03/04/2009 04:19:20 PM
Interesting you never mentioned an inter vivos revokable trust. How come ?? A will should be mentioned in the process.
Posted by: Matt Murphy at 03/04/2009 05:43:51 PM
The best way, if people are insurable, is to do an annuity straddle - roll the IRA into an annuity taking the income stream to pay for the life insurance premiums and at the time of death your heirs get the insurance benefit - tax free. A much better way to transfer the assets.