Who will inherit your IRA?

Key Points

Q: I am in the process of rolling over my retirement plan to an IRA and need to provide beneficiary designations. What should I know in order to make for an efficient transfer upon my death?

You will also be asked to name beneficiaries, in which case the agreement may govern distribution of your account balance at the time of death.

From the standpoint of those who inherit a traditional IRA (as opposed to a Roth IRA), it's important to have an understanding of the unique rules associated with the process. This process is different for spousal beneficiaries and non-spouse beneficiaries.

Spouse and non-spouse transfers

As an alternative, you may leave the IRA in your spouse's name with you as the beneficiary. If your deceased spouse died after age 70½, you generally must base subsequent RMDs on the longer of your single life expectancy or the deceased life expectancy. Otherwise, distributions may be based on your single life expectancy or the account must be totally liquidated in 5 years. Another option is to roll over the inherited IRA assets into your own IRA. The rollover is exempt from current tax liability if completed within 60 days. Using a "trustee to trustee" transfer avoids tax withholding on the distribution from the IRA.

If, on the other hand, you inherit an IRA from someone other than a spouse, you cannot treat the IRA as your own. Thus, you are not allowed to make subsequent contributions to the inherited IRA, nor can you roll over the funds to your own IRA. You can, however, still arrange a trustee-to-trustee transfer to another IRA maintained in the name of the deceased owner, with you as the beneficiary. You must begin taking RMDs subject to the rules for IRA beneficiaries. Distributions from an inherited IRA are taxed at ordinary income tax rates. If you fail to take an RMD, you must pay a penalty tax equal to 50% of the required amount of the distribution.

Contingent beneficiaries

Typically, married IRA owners will name their spouse as beneficiary, due to the many advantages of doing so, while either not naming or giving very little consideration to whom the contingent beneficiary should be. Those who do name a contingent beneficiary often name their children. Caution does need to be exercised in the event that one of the named children dies prior to the IRA owner. Generally, the deceased child's portion of the inheritance would go to the other living children, as opposed to the deceased child's family. This may indeed be your objective.

If, on the other hand, your desire is to have your child's portion pass through to his or her heirs, be sure to add the line: "to my descendents per stirpes." The Latin term "per stirpes" means "by branch." This specific legal terminology will ensure that if the beneficiary child dies, his/her descendants get the full share.

Joel M. Blau, CFP, is president and Ronald J. Paprocki, JD, CFP, CHBC, is chief executive officer of MEDIQUS Asset Advisors, Inc. in Chicago. They can be reached at 800-883-8555 or blau@mediqus.com
or paprocki@mediqus.com
.