Bulletins

Individual Retirement Accounts - Part 2 of 5

by Dennis W. Donnelly, CPA, PFS

Dear clients and friends,

In our last installment we discussed the general eligibility requirements of Traditional and Roth IRAs, as well as the income limitations and contribution limitations.

If you missed Part 1, click here to jump to that article.

All IRAs must eventually be distributed, so it is crucial to plan for this eventuality. It is also of importance to name a beneficiary of your account and to know the consequences of not keeping your named beneficiary current. 'Designated beneficiary' has a very meaningful definition with respect to the distribution of IRA assets at death, in that it must be a natural person, such as a spouse, child, parent, sibling or a friend, all of which have a life expectancy that can be determined. Using a non-natural beneficiary such as a charity, a corporation or a non-qualified trust will disqualify the account from being able to use an extended distribution period.

Primary and Contingent Beneficiaries

When choosing beneficiaries, an IRA owner should select both a primary and a contingent beneficiary. A primary beneficiary is a person or entity named to receive the benefits of an IRA at the owner's death. In other words, the primary beneficiary stands first in line to receive IRA assets.

A contingent beneficiary will receive the IRA assets only if the primary beneficiary predeceases the IRA owner or decides to disclaim the inheritance for estate planning purposes. By naming a contingent beneficiary, an IRA owner can ensure that the IRA will be transferred according to his or her wishes rather than by default to the owner's estate or to another unintended beneficiary.

IRA owners can name more than one primary and more than one contingent beneficiary. If multiple beneficiaries have been named, primary or contingent, the IRA owner must clearly state on the beneficiary form, the name of each beneficiary along with the exact share of the IRA the beneficiary is to receive, such as a faction, percentage of the account or an equal share if that is how the IRA assets are to be distributed.

Spouses as Beneficiary

Most IRA owners name a spouse as beneficiary in order to provide for them financially after death. In this case, there will be no estate tax imposed on the IRA because there is an unlimited amount of property that can be transferred from one spouse to another free of estate tax by using the marital deduction (provided the spouse is a U.S. citizen).

A spouse who is named sole beneficiary has certain privileges that are not available to other beneficiaries after an IRA owner death, as we will discuss later in this installment. A spouse can roll over an inherited IRA to a new or existing IRA in his or her own name and then can name new beneficiaries. Only a spouse can do a rollover, which gives the spouse full control of the IRA assets and permits him or her to delay taking distributions until reaching age 70 ½.

Keep in mind that for spouses to enjoy this additional planning option, a surviving spouse must be the sole primary beneficiary. If a spouse is named as co-beneficiary with children or others, the spouse will be treated as a non-spouse beneficiary for distribution purposes. This means that the spouse cannot roll over the IRA into his or her own IRA and cannot defer distributions until the year he or she turns age 70 ½.

Naming a spouse as sole beneficiary may also affect the amount of an IRA owner's required minimum distribution (RMD) during life. For example, if a spouse is more than 10 years younger than the IRA owner and is the sole beneficiary of the IRA, the owner must use the Joint Life and Last Survivor Life Expectancy Table to find the applicable distribution period and to calculate the RMD. This table gives an IRA owner a smaller RMD than if the uniform Lifetime Table was used.

Nonspouse Beneficiaries

Along with spouses, virtually anyone can be the beneficiary of an IRA, including a child, grandchild, sibling, parent, friend, trust, estate or charity. As noted earlier, if an IRA owner names a charity, corporation, nonqualified trust, or estate as beneficiary, the IRA is considered to have no designated beneficiary for distribution purposes. Even naming such entities as co-beneficiary with a natural person will cause the IRA to not have a designated beneficiary.

No Designated Beneficiary

If an IRA has no designated beneficiary, the entire account must be distributed within five years after then IRA owner's death or over the owner's remaining statistical life expectancy, depending on the type of IRA and when the owner died. This could subject the beneficiaries of large IRAs to a significant tax bill. When a designated beneficiary is named, distribution of the IRA can be extended over the beneficiary's life, resulting in smaller payouts and additional years of tax-deferred compounding.

In our next installment we will examine 'Look Through' Trusts, the 'Timetable for Determining Beneficiaries'; and we will review a 'Beneficiary Checklist'.

Go to Part 3.

Very truly yours,

Dennis W. Donnelly, CPA, PFS
Daniel A. Kosmatka, CPA, PFS, CFF, CGMA
Michael R. Gohde, CPA, PFS