One of the first and most important pieces of information you will fill out on your IRA paperwork is naming a beneficiary in the event you pass away before the funds have been completely distributed. Since your IRA is not directly linked to your Will, your inheritors need to be clearly defined in both documents, even if you plan on using the same divisional scheme. Not naming a beneficiary for your IRA can lead to disastrous consequences. So, who can you name as a beneficiary? Everyone has different family bonds or none at all, so it’s important to choose an inheritor or inheritors that best fit your needs and wishes. Below are the five types of beneficiaries you can name on your IRA.
- If you are married you will probably want to list your spouse as your primary beneficiary, as they can roll the funds into their own IRA account, use the funds to cover funeral costs and debts, or use the funds to cover cost of living without your income. If they roll the funds over into their own IRA, the distributions will be based on their own life expectancy, not yours. They can also name their own beneficiaries at this point for when the time comes to transfer the funds down the line.
If your family is blended and you don’t completely trust that your spouse will exert fairness to your children with the funds after you pass, you can divide your account however you wish between however many parties you wish to ensure everyone receives their fair allotment. If you were ever divorced and don’t want your ex to benefit from your account after your passing, be sure to update your forms to your current spouse, children, or somebody else. After you die, the forms can’t be changed and your ex will legally be entitled to the money.
- Children, grandchildren, other. If your spouse passed before you, or you’re currently unmarried, the most popular second option is to pass the funds to children, grandchildren, or another family member or friend. Keep in mind, the inheritor can choose what they will do with the money once it’s in their name. They can open their own inherited IRA to grow the funds tax deferred until they reach retirement age, or they can just cash out immediately and not take complete advantage of the fund growth.
- If you don’t trust an inheritor to make wise decisions with their inheritance, either because of age or personality, you can name a trust as a beneficiary to maintain a bit more control over the funds after you pass. The distributions from your IRA go directly into the trust, and the inheritors you have listed in the trust will only gain access to the money when you want them to. Your written instructions will dictate who gets money, how much they get, and when they get it. Distributions from your IRA will then be calculated by the life expectancy of the oldest person listed in the trust. While this option provides the most amount of control, it also gives less growth potential and may cost more in taxes and fees than an inherited IRA.
- If you don’t name a beneficiary, or don’t have any living relatives to name, the money in the account will default to your estate, which may be used to pay off debts first before distributing the leftover money to heirs. Since the funds would be distributed immediately to the estate, the total will be subject to income tax and possibly estate tax as well if your assets are worth more than $5,490,000 (2017). This option also disallows for maximum growth potential, so it can be the least advantageous choice unless the account holder has no other options.
- If you have a traditional IRA with tax deferred funds, you may consider giving all or part of your account to a charity. Charities can accept funds without paying income tax, and your family may deduct the donation from your total estate to avoid paying estate tax. If you have a large estate and several accounts to divide between family members, you may consider the counsel of a specialized attorney to ensure you’ve covered all your bases.
Before you choose your beneficiaries, be sure to talk to your financial advisor about the best possible options for you. They will also help you set up contingency plans in case situations change. When it comes to leaving money to your relatives, you can never be too careful.