By Justin C. Kuntz, CFP®
While in most cases people name individuals as beneficiaries on their IRA (Individual Retirement Account), some alternatives should be considered. It is not uncommon for parents and family members to have concerns around how their heir may handle the sudden sum of money when they receive it. Naming your beneficiary correctly is an integral aspect of sound estate planning and all options must be considered.
Types of Beneficiaries
Individuals are the most common beneficiaries of the IRA, most often a spouse or in equal shares to children. However, there are two categories for individuals that must be considered by the IRA owner.
Eligible Designated Beneficiaries
- Spouse of the owner
- Children of the owner less than 18 years old
- Disabled individual
- Chronically Ill individual
- Any other individual who is not 10 years younger than the deceased IRA owner
These individuals can withdraw the balance from the IRA over the owner’s or their own life expectancy, whichever is longer. The spouse of the owner may also roll the inherited IRA into their own IRA, where their own required distribution rules would apply.
- A named individual that is not included in the list of eligible designated beneficiaries.
These individuals must withdraw the balance from the IRA within 10 years following the date of the owner’s death.
Not Designated Beneficiaries
- Most Trusts
If the IRA owner died before age 72, the beneficiary must distribute the balance from the IRA within five years of the date of death.
Naming a Trust as Beneficiary
Despite some limitations, there are good reasons to designate a trust as a beneficiary instead of an individual.
Valid Reasons to Name a Trust
- Limiting a beneficiary’s access
- Second Marriage or mixed family structures
- Beneficiary ownership limitations
- Special Needs individuals, minors, etc.
- Naming additional successive beneficiaries
- Estate planning strategy to minimize estate tax
- Creditor Protection
Required Minimum Distribution Rules for Trusts as Beneficiary
- Conduit Trust: The trust distributes the assets to the beneficiaries when received by the trust. Each beneficiary can choose their distribution schedule within the rules above, if eligible. If non-eligible, distributions must occur by the end of the tenth year and the beneficiaries pay the required taxes. This is most similar to naming an individual beneficiary and does not provide substantial additional value.
- Accumulation Trust: Allows for the accumulation of IRA distributions within the trust, rather than an immediate payout. As a result, the IRA assets are distributed within ten years, and the trust pays the tax, and the terms of the trust designate when and how distributions are paid to the named beneficiaries.
- If the owner dies before 72, IRA assets must be distributed within 5 years.
- After age 72, IRA distribution is based upon the life expectancy of the IRA owner, or the trust can designate the use of the 5-year rule.
RMD Rules are different than distribution rules within the trust. Even if a trust must distribute assets from an IRA within a designated period, the trust still defines when the beneficiaries receive those funds. After-tax proceeds from an IRA can remain invested with the other assets of the trust until the trustee distributes funds.