Estate Planning With IRAs: Exploring Beneficiary Options

Beneficiary options with retirement assets can be more involved than initially thought.  Usually, Individual Retirement Accounts (IRAs) pass by beneficiary designation with primary and contingent beneficiaries.  Although it sounds straightforward enough, careful thought and planning must go into deciding to whom and under what circumstances you want to leave your retirement savings.

Spouse as Sole Beneficiary

A spouse as beneficiary of an IRA has many options.  The spouse can elect a lump sum distribution of the IRA assets without a 10% penalty if the spouse is younger than 59 ½.  A spouse may also elect to receive decedent’s entire IRA over the five years immediately following decedent’s death.  Lastly, based upon the spouse’s age and decedent’s age at death, a spouse may either convert decedent’s IRA into an “Inherited IRA” and begin receiving distributions over the spouse’s life expectancy, or wait and let the IRA balance grow until the decedent would have reached the mandatory distribution age of 70 ½. Lastly, if immediate income is not an issue a spouse can roll-over decedent’s IRA into his or her own IRA and let the IRA assets grow tax deferred until the spouse’s required minimum distribution (“RMD”) kick-in at age 70 ½.

A spouse that is younger than 59 ½ and needs the money would be better off to opt for an Inherited IRA so that he or she can access the money and receive distributions over his or her lifetime without a 10% early withdraw penalty.  In the future, the spouse can roll-over the Inherited IRA into his or her own IRA.

However, the age of the decedent account holder is also an important consideration.  If a decedent was age 65 at death, and the surviving spouse was age 71, the spouse may elect an Inherited IRA because he or she can then wait until decedent would have reached age 70 ½ to begin receiving RMDs on the spouse’s then life expectancy.  This method allows the Inherited IRA to grow tax deferred for an additional 5 ½ years before the spouse would have to take RMD.

Non-Spouse Sole Beneficiary

If the decedent was younger than 70 ½, a non-spouse sole beneficiary may elect to convert to an Inherited IRA and begin receiving distributions immediately over his or her life expectancy; receive distributions over 5 years; or elect a lump sum distribution immediately.  The 10% early withdraw penalty (beneficiary younger than 59 ½) does not apply to inherited distributions, however, income taxes will apply to all distributions.  These options are available regardless of the decedent’s age.

If the decedent was older than 70 ½ at the time of death, the non-spouse beneficiary may only open an Inherited IRA with distributions to occur over the non-spouse’s life expectancy, or the non-spouse beneficiary may elect a lump sum distribution.   A non-spouse beneficiary may not roll-over decedent’s IRA into their own IRA or wait until decedent would have reached 70 ½.

Although the 10% penalty is waived for spouse and non-spouse Inherited IRAs, distributions from an Inherited IRA is subject to income taxes.

A sub-group of non-spouse beneficiaries are minor children as beneficiaries.  A number of issues arise when leaving IRA assets to a child beneficiary.

Who will receive mandatory distributions on behalf of a child?   Will the child have unfettered access to the IRA assets when they turn eighteen?

One way to address these issues is to use a Stand Alone Retirement Trust (SRT) that holds the IRA assets on behalf of the minor child.  Under an SRT the trustee either accumulates the IRA distributions on behalf of the child (for future use) or pays the distributions to the child’s then guardian.  Later on when the child beneficiary reaches a certain age the SRT would grant the child beneficiary (now an adult) control over the remaining IRA assets.  An SRT is a great way to ensure that a child beneficiary’s IRA asset will serve their best interests until a predetermined age at which time the adult child can exercise dominion over the remaining IRA assets.

Guest post contributed by Dirk Winkler, local estate planning attorney.

Dirken D. Winkler is the founder and owner of Winkler Legal Services, LLC, a law firm dedicated to providing central Ohioans with Estate Planning, Probate and Trust Administration services.

If you have any questions or concerns regarding beneficiaries of your IRA assets, please contact Dirk at 614-461-5708, or dirk@dwinklerlaw.com.