Proper beneficiary designations are a must for IRAs, other retirement plans

Related Attorney(s): Steven A. WiddesAnn G. JakabcinDavid S. De JongMicah A. BonaviriCaroline Ford BonaviriDavid B. Torchinsky Kevin P. Fay

Media Type: Alert

Individual Retirement Accounts (IRAs) and other retirement plans frequently comprise a significant portion of a person’s estate. Therefore, it is important to remember that the signing of your Will or Revocable Trust does not necessarily signify the completion of your estate plan. In fact, your estate plan is typically not complete until you have properly designated beneficiaries of your IRAs and other retirement plans. The most common beneficiary designations are spouses, children, grandchildren or other loved ones. Yet it is also possible to name a trust, a charity, or some combination of the above. In making this decision, many clients consider the financial circumstances of potential beneficiaries. However, we encourage clients to weigh just as heavily the tax consequences of their designations.

If an individual fails to designate a beneficiary during his/her lifetime, many plans by default will make payment to the individual’s estate. When the plan’s proceeds pass through an estate, they will be distributed according to the decedent’s Will, if one exists. In theory, this is convenient because the proceeds will pass in accordance with the terms of the decedent’s Will (i.e., to a spouse, child, or other beneficiary). However, in many scenarios this can mean losing a significant percentage of proceeds to taxes.

Generally speaking, designated beneficiaries may take required minimum distributions (RMDs) from an IRA or other retirement plan over their own life expectancies. This approach, which in most situations allows the beneficiary to use his/her own life expectancy, extends the tax benefits of the retirement account by spreading the payout of its proceeds over the longest possible period. In many cases, this means tax deferral can be extended by decades. In contrast, when an estate is designated as the beneficiary, in certain circumstances the plan proceeds are required to be paid out within five (5) years. This means losing the opportunity for further income tax deferral.

There are advantages to coordinating beneficiary designations for IRAs and other retirement plans with your overall estate plan. To accomplish this, even if you have executed a Revocable Trust and/or a Will, you still need to properly designate a beneficiary of your IRA or retirement plan. Remember, the proceeds from an IRA or retirement account should pass to a person (and in some cases a trust or a charity) designated as the beneficiary on a separate beneficiary designation form. Generally, these proceeds should not pass through your estate.

Using proper beneficiary designation language will help you avoid the payment of unnecessary taxes after death. However, there are additional potential problems with allowing IRA or retirement plan proceeds to pass through the estate. These include (i) the risk of exposing the plan benefits to creditors of the estate; and (ii) the payment of income taxes at rates that are typically higher than those for individuals. If you have any questions about this or other estate planning issues, please contact a member of our Estates + Trusts department at 301-340-2020.

Estates + Trusts at Stein Sperling

Stein Sperling’s Estates and Trusts practice provides a broad range of services that include the organization and development of estate plans, assistance in the administration of trusts and estates, and working with clients step-by-step through the probate process. Our attorneys combine experience, knowledge and the practical applications of estate, trust, business and tax laws with innovative approaches designed to meet clients’ needs and objectives.

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