Naming Backup Beneficiaries For Your IRA

Published: 16th February 2010
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Choosing alternate heirs for your IRA can maximize loved one's tax benefits.

Some people build more than enough assets. Even in retirement, they don't need to tap their IRA for living expenses. Such people can hold off taking money from tradtional IRAs until they must take required minimum distributions (RMDs). They must begin by April 1 of the year after the year they reach 70 1/2.

Required distributions are set by IRS tables. Any shortfall is subject to a 50% penalty.

Roth IRAs are different. If you're the original owner of one, you never have to make withdrawals, though your heirs do.

So with either a Roth or a traditional IRA, you might be able to leave a sizable amount to one or more beneficiaries. If you plan well, those heirs may be able to enjoy big tax advantages.

You must name beneficiaries carefully. No matter what your will says, IRAs pass to beneficiaries you have named. A so-called cascading beneficiary plan can save the most on taxes. Here's how such a plan can work.

Let's assume that a hypothetical Bill Jones leaves his job, where he had a 401(k) account. He rolls that over to an IRA. Jones names his wife, Mary, as the primary beneficiary of his IRA. He can also name their children as secondary beneficiaries. This will give Mary flexibility in deciding who gets the assets.

When Bill dies, Mary can claim the inherited IRA as her own. She can then name their children as the beneficiaries of this inherited IRA. What if Mary feels that she won't need the IRA? She can disclaim the inheritance, and the children will get the account.

While alive, Bill also can name their grandchildren as tertiary beneficiaries. If Mary and the children disclaim, the IRA will pass to the grandchildren. The process can extend to any generation and nonfamily members, so long as there's a specific person Bill can name. A trust can be among the listed beneficiaries too, and the trustee can disclaim.

Strategic Steps.

Why are these steps necessary? Someone who disclaims an inheritance can't direct where those assets will go. Instead, a person disclaiming steps out of the line. The assets pass to the next one on the list.

By specifying beneficiaries in descending order, you as the original account owner can influence where the money goes.

Disclaimers must be made within nine months of the original account owner's death. Your surviving family members can look at current tax law and individual finances to decide which of them gets the money from an inherited IRA.

What are some of the potential advantages?

Estate Tax Savings

Say Bill Jones dies with a $1 million IRA but few other assets. His widow, Mary, is also ederly and in poor health. But she has a large estate of her own, not counting her husband's IRA. She built up her wealth in her younger days as a real estate agent.

If Mary accepts the inherited IRA, she may be adding $1 million to her taxable estate. That could lead to thousands of dollars in extra estate tax.

Mary's disclaimer keeps the assets in Bill's estate. His estate is small enough to escape the tax at his death, thanks to the estate tax exclusion.

There also may be estate tax advantages if the children disclaim in favor of Bill's grandchildren.

(The Economic Growth and Tax Relief Reconciliation Act of 2001 includes the repeal of federal estate taxes for people dying after December 31, 2009. It's very important to be aware that this repeal is temporary; the entire law "sunsets" (expires) after December 31, 2010. This means that the provisions of this 2001 Tax Act will no longer be effective on January 1, 2011 and the tax structure as it existed in 2001 will take effect again (in 2011, Federal estate tax will be assessed on property in excess of $1 million with a maximum tax rate of 55%.)


Income Tax Deferral

Minimum distribution rules apply to inherited IRAs. With a traditional IRA, taking only the smallest payout required yearly can prolong tax deferral. With an inherited Roth IRA, minimum distributions also let earnings keep growing tax-free.

If an older beneficiary disclaims in favor of a younger one, the younger heir can stretch required distribution over a longer life expectancy.

A 58-year-old beneficiary would have to empty an inherited IRA within 27 years. But his 20-year-old daughter could stretch required distributions over 63 years. So her distributions can each be smaller. The RMDs must begin in the year after the year of the original owner's death. That lets more of her money stay inside the account. There, it can grow without earnings being taxed until withdrawal.

To make such plans work, all beneficiaries must be specifically identified on IRA beneficiary forms. You can't list "grandchildren" or "great-grandchildren" as a group. But some beneficiary forms don't have enough space to list everyone. If you don't have enough space, you should not name anyone on the form. Instead, write something like, "See seperate sheet of beneficiaries attached." On that sheet, list all primary and contingent beneficiaries. When there are multiple beneficiaries, use fractions or percentages to specify how the inheritance will be shared. Or write "equally." If you use fractions or percentages, make sure they add up to 1, or 100%.

Whenever you move IRA money to a new financial institution, go over the process again. Always ask for an acknowledgment letter from the IRA custodian, saying that your beneficiary form has been received and its provisions will be followed.$

Ray Buckner (Chicago, Illinois) provides personal financial planning and wealth management services for professionals in the greater Chicago metropolitan area. His primary focus is serving pre-retirees who are preparing for a successful retirement as well as those who have already retired and want to develop a 100% retirement income personal paycheck. His pre-retiree clients want to focus on replacing 100% of their last year's income and keep their current standard of living through out their retirement adjusted each year for inflation.
Ray Buckner (Chicago, Illinois) provides personal financial planning and wealth management services for professionals in the greater Chicago metropolitan area. His primary focus is serving pre-retirees who are preparing for a successful retirement as well as those who have already retired and want to develop a 100% retirement income personal paycheck. His pre-retiree clients want to focus on replacing 100% of their last year's income and keep their current standard of living through out their retirement adjusted each year for inflation.
www.promoneyreports.com/rbuckner

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