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January, 2005 Tax Tip

Be Tax Careful With Your IRA Beneficiary

For many people, IRA accounts are a major asset of their estate.  Therefore, if you have an IRA, it goes without saying that you will want to ensure that the funds end up in the hands of your intended beneficiaries in a tax-advantaged manner. To do this you must put your intentions in writing with your IRA custodian.

You may have named an IRA beneficiary many years ago when you opened the account.  You should review this periodically, especially when your personal circumstances change.  IRA beneficiaries override a will.  It may come as a surprise that people who remarry often forget to change the IRA beneficiary from the former spouse to the new spouse.

IRA beneficiaries are described generally as being a spouse or non-spouse. Furthermore, your IRA beneficiary can be a person, a trust or a charity. Each designation has particular pros and cons that you have to weigh carefully in order to make sure your wishes are carried out tax efficiently.


Pro: Your surviving spouse can make a tax-free rollover of your IRA into an IRA in his or her own name.  Distributions from this account are taxed at your spouse's rate and required minimum distributions are determined based on your spouse's age.

Con: Leaving your IRA to your spouse may mean that your tax-free federal estate tax exclusion amount, up to $1,500,000 in 2005, is not used.  If you have substantial assets, you should speak to an estate planning professional who can offer suggestions on how to reduce or possibly eliminate the tax liability for your family's current and future generations.

Person other than spouse

Pro: If you leave your IRA to your children or grandchildren, your IRA would likely provide your heirs with a lifelong stream of income that is far longer than your spouse’s stream of income would be.  In addition, the inherited IRA could continue to grow tax-deferred for many additional years, if the transfer of assets is handled properly.  All distributions are exempt from any ten percent premature distribution penalty and, in any given year, the non-spouse beneficiary is allowed to accelerate distributions without penalty.

Con: Non-spouse beneficiaries are not allowed to roll inherited IRAs into their own IRA.  If the IRA is not passed along correctly, taxes may be due immediately.

While your non-spouse beneficiaries have the opportunity to defer income taxes on your IRA for many years, any estate taxes must be paid in cash no later than nine months following your death.

Minor children may not inherit an IRA until the age of majority. A trusted custodian must be designated for the child, or else the local probate court will appoint someone to handle the account for the child.


Pro: Having a trust as a beneficiary ensures that the assets will be professionally managed according to your wishes.  A trust may provide you and your heirs with asset protection from creditors.

Con: In most cases, designating your estate or your trust as a beneficiary entails the expense of professional asset management.  Also, your beneficiaries by being locked into the terms of the trust, may not be able to manage the assets as they might choose.


Pro: Leaving IRA assets to a charitable beneficiary may be more tax-efficient than leaving the assets to a person since these assets are not subject to estate taxes.

Con: Assets left to a charity will be totally removed from your family.

Selecting the right beneficiary for your IRA can be complicated. Remember to look at your IRA assets in context with the rest of your estate before making any decisions. You should discuss the subjects of beneficiaries, wills and other estate matters with your tax professional to be sure your decisions are appropriate for your situation.




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