Best and Worst IRA Beneficiaries PDF 10-5-2016 · But picking proper beneficiaries can be tricky....

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Best and Worst IRA Beneficiaries Vance R. Parker, JD, MBA

WhenyouchoosebeneficiariesforyourIRAaccount,youinsureout-of-probatetransferstothosebeneficiarieswhenyoudie. Butpickingproperbeneficiariescanbetricky.Here'salistofthebestandworstIRAbeneficiarychoices:BESTIRABENEFICIARIES 1.YourSpouse Ifyouaremarried,it'slikelythatthefirstpersonyouwanttobenefitisyourspouse.YourspouseistheonlypersonthattheInternalRevenueServiceallowsto"rollover"theIRAparticipant'sIRAtotheirownIRAaccount.TherolloverwillallowyourspousetothencontrolyourIRAassets,andtoinvestthemasheorshelikes. IfyourspousedoesnotneedtheIRAfundsimmediately,heorshecankeepthemgrowingtax-deferreduntilApril1followingtheyearheorshereachesage701/2.Atthattime,annualtaxableRequiredMinimumDistributions(RMD)willbegin.Theremainderoftheaccountnotrequiredtobedistributedcancontinuetax-deferredgrowth. 2.YourChildren,Grandchildren,orYoungerIndividuals Withtheexceptionofyourspouse,choosinganindividual(orindividuals)asyourIRAbeneficiaryallowsthatbeneficiary(followingyourdeath)toreceivethemoneyasaninheritedIRA. WiththeinheritedIRA,RequiredMinimumDistributions(RMDs)willbeginintheyearfollowingtheoriginalaccountowner'sdeath.TheseRMDsarecalculatedbasedonthebeneficiary'sage-basedactuariallifeexpectancy.TheIRSprovidesaworksheetforcalculatingRMDsathttps://www.irs.gov/publications/p590b/index.html TheyoungerbeneficiarycanpulloutmorefundsthantheannualRMDrequiresifneeded,buttheadditionalwithdrawalswillalsobetaxed. IftheyoungerbeneficiarycanaffordtolettheIRAprincipalcontinuetogrowtax-deferred,theyoungerbeneficiary'slongerlifeexpectancycanlowertheannualRMD,andstretchtheIRA'stax-deferredgrowthoveralongerlifetime.IntentionallyusingthisstrategytogrowtheIRA'stax-deferredprincipalfromonegenerationtothenextiscalledthe"stretchIRA"concept.

Whenusedproperly,growingyourIRAbyleavingittoayoungerindividual(s)whocanaffordtostretchouttheinheritedIRA'stax-deferredgrowthcanprovidesignificantreturnstothebeneficiary.Assuminga7%returnwithonlytheannualRMDwithdrawn,a$100,000IRAlefttoa20yearoldchildorgrandchildcanprovide$1,765,731inincomeoverthatchild'sexpected63yearlifetime.Pleaseseethechartbelow:TOTALINCOMEFROMIRAOVERBENEFICIARY'SLIFETIME ValueofIRAWhenInheritedbyBeneficiaryAge LifeExpectancy $50,000 $100,000 $500,00020 63 $882,865 $1,765,731 $8,828,65850 34.2 $201,067 $402,134 $2,010,671

3.ASee-ThroughTrust Atrustwhichqualifiesasa"see-through"trustunderIRSregulationscanbeanappropriatebeneficiaryforyourIRA.TheremaybemanypracticalreasonstoemployatrustinsteadofgivingIRAassetsdirectlytoabeneficiary.Forexample,afatherwantingtoleavea$250,000IRAaccounttohis14and16yearoldchildrenwouldbewisetoprotecttheproceedswithatrustinsteadofdirectingthefundstohischildrendirectly. Ingeneral,leavinganIRAtoanon-humanentitylikeanestateoratrustruins"stretchIRA"optimization,becausesuchbeneficiariesmustwithdrawallfundswithinfiveyears(insteadof63yearsfora20year-oldindividual,forexample.) ButunderIRSregulations,the"see-through"trustisableto"seethrough"thetrustentitytotheindividuallifeexpectancyoftheoldestbeneficiaryofthetrust. Toqualifyasasee-throughtrust,thetrustmustmeetthefollowingIRSrules:

• Thetrustmustbevalidunderstatelaw;• ThetrustmustbeirrevocablefollowingtheIRAparticipant’sdeath;• Trustbeneficiariesmustbeidentifiable;• TheIRAplanadministratormustbeprovidedwithproperdocumentationregardingthe

trustbeneficiariesand/orthetrustbyOctober31oftheyearfollowingtheparticipant'sdeath;

• Alltrustbeneficiariesmustbeindividuals. Typicaltestamentarytrusts(foundinwills)orrevocablelivingtrustsbecomeirrevocableafterthedeathofthewilltestatorortrustgrantor.Ifproperlydrafted,andwithproperbeneficiaries,suchtrustsmayqualifyassee-throughtrustsundertheaboveIRSrules.

4.ACharity Atax-deferredaccountmaybeappropriatetogivetoacharity,ifnoneofyourhumanbeneficiariesneedthefunds.Youcantransferthefulltax-deferredIRAvaluetothecharitybecausethecharitywillpaynoincometaxeswhenitreceivesthemoney,andtheaccountwillnotbeincludedinyourtaxableestatewhenyoudie(reducingtheamountthatyourfamilywillhavetopayinestatetaxes,ifapplicable.)WORSTIRABENEFICIARIES 1.YourEstate NamingyourestateasyourIRAbeneficiaryisabadidea.ThisinsuresthattheIRAfundsmustnowgothroughprobate,increasingthetime,complexity,andexpenseofyourprobateestate.TheIRA'screditorprotectionwillbelost,makingyourIRAfundsnewlyeligibletopayestatedebts.YourintendedbeneficiarieswillnolongerbeabletostretchouttheirRequiredMinimumDistributionsovertheirlifetimes(andsavetaxdollars)becausetheIRAfundswillnowberequiredtobefullywithdrawn(andtaxespaidonthewithdrawals)withinfiveyears. 2.AnIndividualandanEntity Inorderfortax-savingstretchIRAprovisionstobeavailabletoyourhumanbeneficiaries,allofyourIRAassetsmustgotohumanbeneficiariesfollowingyourdeath. Forexample,youmayintendforyourtwochildrentobeabletostretchouttheirRequiredMinimumDistributionsovertheirlifetimes,leaving95%ofyourIRAtothemand5%ofyourIRAtoyourchurch.ButeventhissmallbequestofyourIRAfundstoyourchurchwilltriggerthefive-yearIRAdistributionruleforyourchildren.HavingtofullydistributeallofyourIRAproceeds(andpaytheassociatedtaxes)overashortfive-yearperiodcangreatlyreducethestretchIRAtaxsavingsavailabletoyourchildren. 3.APersonwhohasProblemsManagingMoneyorwhoisinDebt ApersonwhocannotmanagemoneywouldwithdrawtheinheritedIRAfundsveryrapidly,withincometaxhavingtobepaidoneverywithdrawal,negatingthepotentialstretchIRAtaxsavingsofaninheritedIRA. Inaddition,unlikewithatraditionalIRA,a2014U.S.SupremeCourtdecisionheldthattheproceedsfromaninheritedIRAarefullyavailabletocreditors.ThusifyouleaveyourIRAoutrighttosomeoneindebt,theymayloseallofthatmoneytocreditorsinashortamountoftime. ToprotectyourIRAassetsdirectedtoabeneficiarywithmoneymanagementproblems,orwithcreditorordebtproblems,considersettingupasee-throughdiscretionarytrustforthebeneficiary.YoucouldthenchooseanotherresponsiblefamilymembertoserveastrusteetomanagetheIRAfunds,andtomakethespendingdecisionsonbehalfoftheencumbered

beneficiary. 4.AnOlderIndividual LeavinganIRAtoanolderpersonfrequentlyinsuresthattheRequiredMinimumDistributionswillbeaccelerated,leadingtoincreasedtaxes.Ifthebeneficiaryreallyneedsthefunds,however,andtherearenoalternativeassetstotransfer,theincreasedtaxationratemaybelessimportantthantakingcareofthebeneficiary.REFERENCESDanielA.Timins,WhoShouldYou(Not)LeaveYourIRATo,Kiplinger(August2016),http://www.nasdaq.com/article/who-should-you-not-leave-your-ira-to-cm660234UnderstandingtheStretchIRAStrategy:PreservingAssetsforYourHeirs,TRowePriceInvestor(March2011),https://individual.troweprice.com/staticFiles/Retail/Shared/PDFs/StretchIRA.pdfNatalieB.Choate,LifeandDeathPlanningforRetirementBenefits,(7thed.2011).UnderstandingWhoShouldBeBeneficiaryofYourIRA,EstatePlanning.com,https://www.estateplanning.com/Beneficiary-of-Your-IRA/