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How to Properly Name IRA Beneficiaries

If you own a traditional IRA, IRS code 401(a)(9) states that you must take required minimum distributions (RMDs) from your IRA when you turn 70½. If you die before these assets are exhausted, your beneficiaries will inherit them and continue to take distributions. Certainly, this can be a disaster if you have the wrong beneficiaries listed. So today, we'll look at how to properly name beneficiaries. (Thanks are due to John Corn, my colleague at Buckingham Asset Management, for the information.)

It sounds simple enough, but without proper estate planning, you may be reducing your family's future wealth potential. That's because improper planning can mean not only a premature end to your IRA at your death, but also assets being inherited by the wrong individuals or entities. How you manage the beneficiaries of your IRA or retirement plan is a crucial planning step to mitigate the risks of leaving your IRA assets to unintended individuals or entities and to help maximize your beneficiaries' distribution options.

Spouses as Beneficiaries Typically, IRA owners name their spouses as beneficiaries. When the IRA owner dies, the surviving spouse can:

  • Roll the funds into his or her own IRA
  • Open an inherited IRA and take distributions based upon his or her remaining life expectancy

In the event that the surviving spouse dies before the inherited IRA assets have been fully exhausted, whatever assets remain may pass on to the next generation.

Children as Beneficiaries IRS regulations allow children who are designated as beneficiaries to stretch the required distributions from the inherited IRA over their life expectancies, just like spouses. Thus, if your child is the beneficiary (instead of the spouse), he or she has a longer period than the spouse over which to stretch the distributions, allowing more of the family wealth to continue growing tax deferred.

Multiple Beneficiaries Under the final RMD regulations issued in 2004, multiple beneficiaries of IRAs are each allowed to use their own life expectancy to calculate post-death RMD amounts. This is true as long as the assets are segregated into separate accounts by December 31 of the same year.

Trusts as Beneficiaries Almost anyone or anything can be the beneficiary of an IRA. Naming a trust as beneficiary allows for maximum control over the tax-deferred money upon death, because the trust will contain your written instructions regarding who, when and how much when it comes to getting the money out of the trust.

(Please note that there are a lot of complexities with naming trusts as beneficiaries, so seek a competent estate planner for assistance with trusts.)

Contingent Beneficiaries If you're designating individuals as beneficiaries (as opposed to trusts), there's always a chance they may not be around when you die. In addition, an individual may not want to inherit that IRA.

For example, a surviving spouse can disclaim his or her interest in the IRA, allowing the funds to pass on to the contingent beneficiaries. This could prove to be a very powerful estate planning strategy if the contingent beneficiaries are children, or even grandchildren, as they're allowed to stretch distributions from inherited IRAs over their life expectancies. Thus, it's just as important to name contingent beneficiaries as it is to name your primary beneficiaries.

Photo courtesy of Holidayextras on Flickr.
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