Choosing Your IRA Beneficiary
Many people think that a will can designate how their individual retirement account (IRA) is paid out, but this is not true. IRA accounts and other types of retirement accounts like 401(k)s, 403(b)s, and 457s, have a beneficiary designation attached to them.
Completing Beneficiary Designation Forms
When you open these accounts, you fill out a beneficiary designation form, and it is used to specify how money in that account is distributed upon your death. Whatever you put on your beneficiary form overrides what you have in your will or your trust if you have one.
If you do not fill out the beneficiary form or complete it improperly, then the default arrangements in the custodial agreement will determine who your IRA goes to. One of the biggest mistakes made on IRA and 401(k) accounts is not properly naming a beneficiary.
Naming a Spouse as Your IRA Beneficiary
Your spouse is the only person who can inherit your IRA and treat it like their own retirement account. The advantage to your spouse if they are named as your primary beneficiary is flexibility upon your death in how they treat the IRA. They can roll it over into their existing IRA or leave it as an inherited IRA. By leaving it as an inherited IRA, they can take distributions as needed.
Once your spouse has inherited your IRA, they can name whomever they would like as the subsequent beneficiaries. If you have children from a previous marriage, the primary concern of naming a spouse is that the spouse might remarry and pass along your IRA assets to someone else, leaving your children out.
Naming a Trust as Your IRA Beneficiary
Frequently, some form of trust is named as the beneficiary of an IRA. It is usually done to protect assets so that a surviving spouse can use them as needed but will not have the ability to change the beneficiary. The goal is to make sure assets are protected.
If you name a trust as a beneficiary of your IRA, the trust must be drafted in a particular way for this strategy to be effective. If done incorrectly, it can cause problems such as forcing the IRA to be paid out on an accelerated schedule rather than each beneficiary having the option to draw it out over their life expectancy.
Some attorneys will draft a special conduit IRA trust for the purpose of managing and distributing IRA assets. This may be a better strategy than naming a standard revocable living trust.
The downside of naming a trust is discussed infrequently. Many IRA accounts are not that large. Requiring a trustee to oversee the management and distribution of the funds can be costly.
It may not be economical to require small accounts to remain in the trust. Before naming a trust as the beneficiary discuss your account sizes with your attorney and see if you can find an option that accomplishes your goals while proving to be economical for beneficiaries.
Some attorneys will draw up a document called a custom beneficiary designation that can offer more specific instructions than the standard beneficiary form that goes with your IRA or other retirement accounts.
Naming Children or Grandchildren as Beneficiaries
If you name minor children or grandchildren as direct beneficiaries, then in your will you need to name a guardian to manage the funds on their behalf until they reach the age of majority (18 or 21, depending on the state.)
If you have a special needs child, or adult child whom you don’t think should inherit the funds outright, you may wish to set up a special needs trust on their behalf.
If you are married and have stable adult children, the simplest and most economical solution can be to name your spouse as your primary beneficiary and your children as contingents.