Pitfalls to Avoid When Naming IRA Beneficiaries

Generally, IRA owners are going to leave their account to a surviving spouse or their children.

While this sounds simple, there are pitfalls to avoid, since the IRS treats IRAs inherited by children different from IRAs inherited by a spouse.

When an IRA is left to a spouse it can be treated as the spouses IRA, possibly postponing required distributions if the spouse is younger. This is not available to the Inherited (by children, grandchildren, etc.) IRA. However, Inherited IRAs are disbursed based on the life expectance of the new owner, not the deceased former owner. Since required distribution (and taxes) will be much smaller, this is a huge tax planning advantage of the Inherited IRA.

For this to work, you must have your individual non-spouse heirs (children) named as IRA beneficiaries. If your IRA first passes to a spouse, children should be named as contingent beneficiaries. After the IRAs owner death, the surviving spouse should make sure the children are the primary beneficiaries. If not, the IRA would pass to the estate, which could subject the IRA to probate cost and creditors. The children also lose the advantage of stretching distributions (and taxes) over their life expectancies.

It is also permissible to name Trusts and Charities as IRA beneficiaries, but the rules for IRAs, 401ks, and other retirement vehicles can be tricky. Always consult with your financial planning fiduciary before naming beneficiaries.