One of the most overlooked items when someone opens an IRA, Roth IRA, Rollover IRA or other retirement account is forgetting to name beneficiaries. Often, beneficiary designation is yet one more form that needs to be completed and often people think to themselves, “I’ll just do this later” and then never finish that task. Today we’ll look at what happens under various scenarios when the IRA account owner passes away.
Spousal Transfer
Our first example will be Ann. Ann is married Dan and Ann did not name a beneficiary to her $500,000 Rollover IRA. Ann passes away and under state law, Dan inherits Ann’s IRA. It moves into his IRA and is not subject to taxes.
Non Spousal Transfer
Our second example is Ann and Dan….but this time, Dan is deceased. Soon, Ann passes away. Ann has no beneficiary named on her IRA, but she does have a child named Ed. Under state law, Ed inherits her IRA. However, since Ed isn’t named as a beneficiary, Ann’s IRA moves first to an IRA titled “The Estate of Ann inherited IRA”. From there, it is distributed to Ed. However, it is not distributed to Ed’s IRA, it is distributed in a check to Ed. Ed is in the 40% tax bracket that year because of the IRA distribution and the $500,000 IRA costs Ed $200,000 in taxes upon distribution. Ed ends up with $300,000 after tax.
Our third example will be again be Ann and Dan. Dan is deceased, and Ann passes away. In this case, Ann has named her child Ed as the beneficiary of her $500,000 IRA. Ann’s child Ed opens an IRA titled “Ed’s Inherited IRA, beneficiary of Ann”. The money passes directly from Ann’s IRA to Ed’s inherited IRA and Ed owes no tax on that transfer. Ed ends up with $500,000 and zero tax liability.
Second Marriages
Our fourth example will be Jan and Fred. Jan and Fred are each in their second marriage and each has adult children. Jan passes away and her IRA goes directly to Fred’s IRA rather than her biological children since Fred is spouse and she named no beneficiary. Shortly after that, Fred passes. Fred’s IRA money (a combination of his IRA savings and Jan’s IRA savings) passes to his adult biological children who were listed as his beneficiaries on his IRA and Jan’s children get nothing.
In looking at the above examples, you can see that a beneficiary designation can make a big difference in the taxation and the distribution of retirement account assets. As we all age, and as we face new health threats such as Coronavirus, it is more important than ever that distributions from your IRA are intentional and planned. We welcome a discussion regarding your IRA beneficiary designations to double check that they align with your intentions.
