IRAs & Beneficiaries

Most people name individuals as direct beneficiaries of their IRAs or other retirement plans. However, by naming a qualified trust as a beneficiary, your heirs could not only save taxes, but also have creditor and other protections. Qualified trusts are underutilized tools for protecting retirement assets.

What will happen if I leave my IRA directly to my spouse?

You usually can leave unlimited bequests, including IRAs, to your spouse with no estate tax consequences. Generally, your spouse may then stretch out the income taxable distributions in installments over his or her lifetime. Upon your spouse’s death, your bequests together with your spouse’s individual assets will be included in your spouse’s taxable estate. Everything more than $2 million would be estate taxed to your heirs at the rate of 45% in 2008. This is on top of the income tax of up to 35% in 2008. With properly drafted qualified revocable living trusts benefiting you and your spouse and by naming your trusts as the primary beneficiary of each of your IRAs, you and your spouse could leave up to $4 million estate tax free in 2008. Distributions from your IRA could still be stretched out over your spouse’s lifetime but could have creditor, remarriage and other protections that are available with trusts.

What happens if I name more than one beneficiary of my IRA?

You may name multiple individuals, such as children or grandchildren, as beneficiaries of your IRA. It is best if the IRA is divided up among these beneficiaries by September 30 of the year following your death, then each beneficiary may stretch out their distributions over his or her lifetime, which also defers income taxes. If you name your beneficiaries’ separate trusts as IRA beneficiaries, your beneficiaries not only may stretch out distributions and defer income taxes over each beneficiary’s lifetime, but also have creditor, divorce and other protections.

What if I do not name a beneficiary of my IRA or my beneficiaries predecease me?

If you do not name a beneficiary of your IRA or your beneficiaries predecease you, your IRA would be distributed as part of your probate estate. Your beneficiaries will lose the ability to stretch out distributions over their lifetimes and may pay more in income taxes. The IRAs may be taxable at estate income tax rates. Estates reached the maximum 35% income tax rate at $10,700 of income in 2008. Single individuals receiving IRA distributions directly or through qualified trusts did not reach the 35% maximum income tax rate until their incomes exceeded $357,700 in 2008.

What if I have assets in an employer qualified retirement plan (i.e., 401(k) or other plan)?

The best thing that you can do is to review your plan. Some employer plans are more restrictive than IRAs. The options that are discussed above regarding IRAs are allowable, but not mandatory for employer plans. If you have a more restrictive plan, consider transferring those plan assets to an IRA to give yourself more options.

Trusts are valuable tools to use for IRA and retirement plan distributions.

By: Matthew M. Wallace CPA, JD

Published edited August 31, 2008 in The Times Herald newspaper, Port Huron, Michigan as: Get expert answers about protecting assets

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