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Understanding
Who Should Be Beneficiary of Your IRA
How to Turn a Modest Inheritance Into Millions for
Your Family.
1. Introduction
2. Don't I have to use this money for my
retirement?
3. How much will I have to take out?
4. Doesn’t my beneficiary affect my
distribution?
5. Whom can I name as beneficiary?
6. Option 1: Spouse
7. How does the spousal rollover option
work?
8. What happens if my spouse dies first?
9. Are there any disadvantages of naming
my spouse?
10. Option 2: Children, Grandchildren,
Others
11. Are there any disadvantages?
12. Option 3: Trusts
13. Are there any disadvantages?
14. Option 4: Charity
15. Option 5. Split Your IRA Into
Smaller Ones
16. What are estate taxes and why should
I care?
17. What can I do about estate taxes?
18. How can splitting my IRA help?
19. What if I'm not married?
20. When can I change my beneficiary?
21. What about the new Roth IRA?
22. Do I need professional assistance?
1.
Introduction
How would you like to turn your modest tax-deferred
account into millions for your family? Depending on whom
you name as beneficiary, you can keep this money growing
tax-deferred for not only your and your spouse’s
lifetimes, but also for your children’s or
grandchildren’s lifetimes. That can turn even a modest
inheritance into millions.
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2.
Don't I have to use this money for my retirement?
When you reach a certain age, usually 70 1/2, Uncle Sam
says you must start taking your money out. (This is
called your required beginning date.) But if you don’t
use all this money before you die, naming the right
beneficiary can keep it growing tax-deferred for
decades.
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3. How
much will I have to take out?
Calculating the amount you must withdraw each year (your
required minimum distribution) is much easier now than
it used to be. Each year, you divide the year-end value
of your account by a life expectancy divisor from the
Uniform Lifetime Table (provided by the IRS). The result
is the minimum you must withdraw for that year. You can
always take out more.
For example, the divisor at age 70 is 27.4. If
your year-end account balance is $100,000, you divide
$100,000 by 27.4, making your first required minimum
distribution $3,650. Each year the divisor is smaller,
but it never goes to zero. Even at age 115 and older,
the divisor is 1.9. “To recalculate or not to
recalculate” is no longer an issue. Everyone now gets
the benefit of recalculating their life expectancy.
(Back to Top)
4. Doesn’t my beneficiary affect
my distribution?
Not any longer. Now, almost everyone uses the same chart
to calculate distributions, even if you have no
beneficiary. After you die, distributions are based on
your beneficiary’s life expectancy (or the rest of your
life expectancy if you die without one.) Naming the
right beneficiary is still critical to getting the most
tax-deferred growth. That’s much easier to do now,
because you are no longer locked into the beneficiary
you name when you take your first distribution.
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5. Whom
can I name as beneficiary?
You have five basic options: your spouse (if married);
your children, grandchildren or other individuals; a
trust; a charity; or some combination of the above.
(Back to Top)
6.
Option 1: Spouse
Most married people name their spouse as beneficiary.
And, in most cases, this will be your best option,
because 1) the money will be available to provide for
your surviving spouse and 2) it gives you the spousal
rollover option.
Also, if your spouse is more than ten years
younger than you are, you can use a different life
expectancy chart that makes your required distributions
even less. (This lets the tax-deferred growth continue
longer on more money.)
(Back to Top)
7. How
does the spousal rollover option work?
If you die first, your surviving spouse can “roll over”
your tax-deferred account into his/her own IRA, further
delaying income taxes until he/she must start taking
required minimum distributions at age 70 1/2.
When your spouse does the rollover, he/she
names a new beneficiary, preferably someone much
younger, as your children and/or grandchildren would be.
After your spouse dies, the beneficiary’s actual life
expectancy can be used for the remaining required
minimum distributions. The results, shown in the chart
below, can be phenomenal.
For example, let’s say your grandson is 20 when
he inherits a $100,000 IRA from your spouse. Over the
next 63 years (the life expectancy of a 20-year-old),
the $100,000 IRA can provide him with over $1.7 million
in income!
Under current IRS policy, your spouse can do
this rollover and stretch out the IRA even if you had
started taking required minimum distributions before you
died.
TOTAL INCOME FROM IRA OVER BENEFICIARY'S
LIFETIME*
Age (20), Life Exp. (63.0)
Value of IRA When Inherited by Beneficiary ($50,000) =
$882,865
Value of IRA When Inherited by Beneficiary ($100,000) =
$1,765,731
Value of IRA When Inherited by Beneficiary ($500,000) =
$8,828,658
Age (30), Life Exp. (53.3)
Value of IRA When Inherited by Beneficiary ($50,000) =
$526,612
Value of IRA When Inherited by Beneficiary ($100,000) =
$1,053,225
Value of IRA When Inherited by Beneficiary ($500,000) =
$5,266,128
Age
(40), Life Exp. (43.6)
Value of IRA When Inherited by Beneficiary ($50,000) =
$321,210
Value of IRA When Inherited by Beneficiary ($100,000) =
$642,421
Value of IRA When Inherited by Beneficiary ($500,000) =
$3,212,106
Age (50), Life Exp. (34.2)
Value of IRA When Inherited by Beneficiary ($50,000) =
$201,067
Value of IRA When Inherited by Beneficiary ($100,000) =
$402,134
Value of IRA When Inherited by Beneficiary ($500,000) =
$2,010,671
* Assumptions: 7% annual return; only required
minimum distributions withdrawn. Income subject to
income taxes.
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8. What
happens if my spouse dies first?
If you don’t remarry, you lose the rollover option. (It
is only available to spouses.) This used to be a
problem, because distributions after your death would
still be based on your and your deceased spouse’s life
expectancies. But now you can name a new beneficiary,
and after you die distributions will be based on the new
beneficiary’s life expectancy.
(Back to Top)
9. Are there any disadvantages of
naming my spouse?
Your spouse will have full control of this money after
you die and is under no obligation to follow your
wishes. This may not be what you want, especially if you
have children from a previous marriage or feel that your
spouse may be too easily influenced by others after
you’re gone.
Also, if your spouse becomes incapacitated, the
court could take control of this money. It could be lost
to your spouse’s creditors. And, finally, naming your
spouse as beneficiary can cause your family to pay too
much in estate taxes. (More about this later.) If any of
this concerns you, keep reading.
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10. Option
2: Children, Grandchildren, Others
If your spouse will have plenty of assets after you die,
if you have reason to believe your spouse will die
before you, or if you are not married, you could name
your children, grandchildren or other individuals as
beneficiary(ies).
This will let you stretch out your account
without the spousal rollover. Remember, after you die,
the distributions can be paid over your beneficiary’s
life expectancy.
(Back to Top)
11.
Are there any disadvantages?
Anytime you name an individual as beneficiary, you lose
control. After you die, your beneficiary can do whatever
he/she wants with this money, including cashing out the
entire account and destroying your carefully made plans
for long-term, tax-deferred growth. The money could also
be available to the beneficiary’s creditors, spouses and
ex-spouses. And there is the risk of court interference
at incapacity. If any of this concerns you, consider
using a trust.
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12.
Option 3: Trusts
Naming a trust as beneficiary will give you maximum
control over your tax-deferred money after you die.
That’s because the distributions will be paid not to an
individual, but into a trust that contains your written
instructions stating who will receive this money and
when.
For example, your trust could provide income to
your surviving spouse for as long as he or she lives.
Then, after your spouse dies, the income could go to
someone else. The trust could even provide periodic
income to your children or grandchildren, keeping the
rest safe from irresponsible spending and/or creditors.
While you are living, the required minimum
distributions will still be paid to you over your life
expectancy. After you die, the required distributions
can be paid to the trust over the life expectancy of the
oldest beneficiary of the trust.
The trustee can withdraw more money if needed
to follow your instructions, but the rest can stay in
the account and continue to grow tax-deferred. You can
name anyone as trustee, but many people name a bank or
trust company, especially if the trust will exist for a
long period of time.
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13. Are there any disadvantages?
You will not be able to provide for your spouse and
stretch out the tax-deferred growth beyond your spouse’s
actual life expectancy. That’s because you must use the
life expectancy of the oldest beneficiary of the trust
which, in this case, would probably be your spouse.
Also, many trusts pay income taxes at a higher
rate than most individuals, but this only applies to
income that stays in the trust. (If you have a revocable
living trust, this would only happen after you die.)
Distributions from your tax-deferred account that are
paid to the trust are subject to income taxes. And if
the money stays in the trust, the higher tax rates would
apply. But usually this is not a problem because the
trustee distributes the money to the beneficiaries of
the trust, who pay the income taxes at their own rates.
Finally, the trust must meet certain IRS
requirements, including that it is a valid trust under
state law.
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14.
Option 4: Charity
If you are planning to leave an asset to charity after
you die, a tax-deferred account can be an excellent one
to use. That’s because the charity will pay no income
taxes when it receives the money. And the account will
not be included in your taxable estate when you die,
reducing the amount your family may have to pay in
estate taxes. (More later.)
(Back to Top)
15.
Option 5. Split Your IRA Into Smaller Ones
You don’t have to choose just one of these options. You
can split a large IRA into several smaller ones and name
a different beneficiary for each one. (If your money is
in a company plan, you can roll it into an IRA and then
split it.)
If you name several beneficiaries for one IRA,
you must use only the oldest beneficiary’s life
expectancy. But with separate IRAs (one for each
beneficiary), you can use each one’s life expectancy,
giving you the maximum stretch out.
This is especially important if a charity is
involved. It has a life expectancy of zero, so the IRS
would consider it the oldest beneficiary. Depending on
when you die, this could cause the entire IRA to be paid
out in just five years.
If you divide your IRA now, you will need to
calculate a distribution for each IRA, but it can be
worth the trouble. Under the new rules, your IRA can be
divided even after you die. Splitting a large IRA can
also save estate taxes.
(Back to Top)
16. What
are estate taxes and why should I care?
Estate taxes are different from, and in addition to,
income taxes. When you die, your estate will have to pay
estate taxes if its net value (including your
tax-deferred accounts) is more than the amount exempt at
that time. In 2002 and 2003, the estate tax “exemption”
is $1 million. Every dollar over $1 million is then
taxed, starting at 41%.
Estate taxes must be paid in cash, usually
within nine months of your death. If money must be
withdrawn from a tax-deferred account to pay the estate
taxes, the result can be disastrous, because income
taxes must be paid on the money that is withdrawn to pay
the estate taxes.
(Back to Top)
17. What can I do about
estate taxes?
You can reduce your taxable estate by giving some assets
to your loved ones now. You can buy life insurance to
pay estate taxes at a reduced cost. And, if you are
married, make sure you use both your estate tax
exemptions.
You see, everyone is entitled to an estate tax
exemption. But many married couples waste one when they
leave all their assets to each other. Currently, you can
leave your spouse an unlimited amount of assets when you
die and there will be no estate taxes at that time. But
when your spouse dies later, he or she will only be
entitled to one exemption. That can cause your family to
pay too much in estate taxes.
(Back to Top)
18. How can
splitting my IRA help?
Any assets you own (including a tax-deferred account)
that you leave to anyone other than your spouse (your
children, grandchildren or a trust) can use your
exemption. Splitting a large IRA into smaller ones will
make this easier to do.
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19. What if
I'm not married?
If you are single, naming a beneficiary(ies) will be
less complicated because you have just one estate tax
exemption and there will be no spousal rollover option
to consider.
(Back to Top)
20. When can I change my
beneficiary?
Under the new rules, you can change your beneficiary at
any time while you are living, and the distributions
after you die will be paid over that beneficiary’s life
expectancy.
In fact, now your final beneficiaries do not
have to be determined until September 30 of the year
after the year you die, which allows for some neat
“clean-up” planning to be done after you’re gone. For
example, your spouse could “disclaim” some benefits so a
grandchild could inherit. No new beneficiaries can be
added after you die; you must have the right
beneficiaries named on your account before then.
Some employer-sponsored plans (401(k), pension
or profit sharing plans, etc.) have restrictions on
beneficiary options. If your plan will not let you do
what you want, rolling your money into an IRA will
usually give you more options. If your money is in an
IRA and the institution will not agree to your wishes,
move your IRA to one that will.
(Back to Top)
21.
What about the new Roth IRA?
If you qualify, you may want to convert some or all of
your tax-deferred money into a Roth IRA. You’ll have to
pay income taxes on the amount you convert, but it can
be well worth it. If you qualify, you can also set up a
new Roth IRA and make after-tax contributions to it.
Unlike a traditional IRA that requires you to
start taking money out at 70 1/2, with a Roth IRA there
are no required minimum distributions during your
lifetime. And, generally, after five years or age 59 1/2
(whichever is later), all withdrawals are income
tax-free. So you can leave your money there, growing
tax-free, for as long as you wish.
You can stretch out a Roth IRA just like a
regular IRA. After you die, distributions can be paid
over the actual life expectancy of your beneficiary.
Your spouse can even do a rollover and name a new
beneficiary. And, remember, all distributions to your
beneficiaries will be income tax-free.
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22. Do
I need professional assistance?
Yes, especially if you have a sizeable amount in
tax-deferred plans and your estate is large enough to
pay estate taxes. The rules are still complicated and
loaded with tax traps and penalties. Also, any time you
name someone besides your spouse as beneficiary, you
need expert advice.
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NOTE: This information is designed to
provide a general overview with regard to the
subject matter covered and is not state-specific.
The authors, publisher and host are not providing
legal, accounting or any other advice which
purports to be specific to your situation. The
contents of this website are believed to be
completely reliable. Nevertheless, some material
may be affected by changes in the laws or
interpretations of such changes since the material
was entered on the website. If legal advice or
other expert guidance is required, the services of
a competent professional in the field of law,
accounting, insurance or investments should be
sought.
Price
& Farrington, PLLC - Attorneys and Counselors at
Law
Parkwood Office Center - 2370 130th Ave. N.E., Suite
103 - Bellevue, WA 98005
Phone: 425.451.3583.. Fax:
425.522.4818 ..E-mail: admin@pricefarrington.com
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