Things You Need to Know About IRA Beneficiary Designation

Last Modified on September 2, 2019

An Individual Retirement Account or IRA is an integral part of any financial planning. Not only does it ensure time savings for a relaxed post-retirement life, but it also provides many tax benefits. Most people are wise enough to open an IRA early in their careers. However, they put off one crucial task – naming the right beneficiary. Not naming or updating your IRA beneficiary list can lead to huge tax implications in the future, with your money being spent on probate and court proceedings. Read on to understand how and why you should avoid making this mistake. 

Role & Importance of a Beneficiary in IRA

A beneficiary is the person/ charity/ organization that is likely to inherit your IRA after you pass away. Thus, having a beneficiary for your IRA is an important aspect of estate planning. 

• If you don’t have a beneficiary for your IRA before you pass away, your account will be automatically included in your estate. This can be a huge tax liability for your family. 
• Another mistake that many people commit is to not update their beneficiary list. Most people believe that if the beneficiary for their IRA passes away, their heirs inherit the account automatically. But this may not always be the case. In order to ensure that your hard-earned money goes into the right hands, you should give in a lot of thought into naming a beneficiary for your IRA and make sure to revise and update it from time to time. 
• If your IRA becomes a part of your estate, it is most likely to go through a probate. Normally, accounts like IRAs, life insurance, annuities, etc. are directly transferred to the beneficiary from the company itself. The company simply verifies the beneficiary records and transfers the money via a check or bank transfer. The process is much simpler and cost-effective as opposed to involving probate. Your loved ones too are not hassled with unnecessary formalities. 

4 Things to keep in mind while designating a Beneficiary for an IRA

1. In case of a minor

Most people who are single, widowed, or divorced, like to nominate their children, grandchildren, or relatives as beneficiaries for their IRA. However, remember that if your beneficiary is a minor, you also need to pick a guardian. Many assume that by the time the IRA is being inherited, the beneficiary would be an adult. But life is unpredictable, and it is good to be prepared all the time. It is essential to have a guardian in place right from the start. If you don’t appoint a guardian and the minor’s parents are no longer alive, the account will be managed by a court- appointed guardian. This can be very confusing for a minor and can end up costing a lot of money and time. 

2. In case of a current spouse

The best and most obvious choice of an IRA beneficiary is your spouse because of the spousal benefits that other beneficiaries don’t qualify for. A spouse can either keep your IRA as an inherited account or roll it over to their IRA. Here are some things to know about inheriting a spousal IRA:

• If the deceased spouse is under the age of 70 1/2, the inheritance does not require an immediate Required Minimum Distribution or RMD. It is only applicable from the year when the deceased spouse would turn 70 1/2. For example: If a wife inherits an IRA from her deceased 60-year-old husband, she doesn’t have to withdraw an RMD for the next 10 ½ years.
• If the deceased spouse is 70 ½ or older, the spouse inheriting the IRA is required to withdraw RMDs as usual.

3. In case of divorce/remarriage

A lot of people add their spouses as the beneficiary, but surprisingly, a majority of them forget to update their beneficiaries in case of a divorce or remarriage. If you forget to do so, the IRA will automatically be inherited by your previous spouse. The only way to deal with this problem after you pass away is by an IRS appeal, which is a very expensive and time- consuming process. Make sure to revisit your beneficiary list in case of any change in your marital status.

4. In case of a trust

Some people like to appoint a trust as the beneficiary; especially, in case of a minor beneficiary. Another reason for choosing a trust is to protect your assets from the possibility of an inheritor changing the beneficiary later. However, trusts can be expensive. If you have a small IRA, most of the money will be spent on the trust, leaving very little for the beneficiary. Trusts are convenient in case of considerably large accounts that require to be distributed over a period of time. It is good to discuss this option with an attorney and make a decision based on the size of the IRA. You must also be very careful and precise while drafting such a trust to avoid confusion in the future. 

An IRA rollover works in 2 ways: Direct and Indirect

Direct Rollover: The deceased spouse’s account is directly rolled over to the IRA of the spouse inheriting the account. 

Indirect Rollover: The company issues a check to the inheriting spouse. Within 60 days, the spouse is expected to roll over the money to their own IRA account. 

To sum it up

Putting aside a certain amount each month is important, but it is also important to consider what happens to this money when you are not around. Delaying beneficiary designation or not putting much thought into picking the right one can be extremely inconvenient for your loved ones. 

Do you need help in picking out the right beneficiary for your IRA? Consult financial advisors! They will analyze your financial situation and make sound suggestions to ensure that your savings are taken care of in your absence.