Many people think that a will can designate how their IRA is paid out. This is not true. IRA accounts and other types of retirement accounts like 401ks, 403bs and 457s, have a beneficiary designation attached to them.
When you open these types of accounts you fill out a beneficiary designation form and it is used to specify how money in that account is distributed upon your death. Whatever you put on your beneficiary from over-rides what you have in your will or in your trust (if you have a trust).
Below I walk through some common issues encountered when determining who to name as your IRA beneficiary.
Pros of Naming Spouse as Your IRA Beneficiary
Your spouse is the only person who can inherit your IRA and treat it as if it is their own IRA. The advantage to your spouse if they are named as your primary beneficiary is flexibility upon your death in how they treat the IRA.
Cons of Naming Spouse as Your IRA Beneficiary
Once your spouse has inherited your IRA, they can name whomever they would like as the subsequent beneficiaries. If you have children from a previous marriage the primary concern of naming a spouse is that the spouse might remarry and pass along your IRA assets to someone else, leaving your children out.
Pros of Naming Trust as Your IRA Beneficiary
I frequently see some form of a trust named as the beneficiary of an IRA. This is usually to protect assets so that a surviving spouse can use them as needed but will not have the ability to change the beneficiary. The goal is to make sure assets go to the children.
If you name a trust as a beneficiary of your IRA, the trust must be drafted in a particular way for this strategy to be effective. Frequently I see this done incorrectly which can cause problems.
Learn more about the provisions necessary if you name a trust as the beneficiary of your IRA account:
- Choosing Beneficiaries for IRAs and 401ks: Initial Considerations
- Naming A Trust as Beneficiary of Your IRA
Some attorneys will draft a special conduit IRA trust for the purpose of managing and distributing IRA assets. This may be a better strategy than naming a standard revocable living trust.
Cons of Naming Trust as Your IRA Beneficiary
The biggest con I see to naming a trust is one I see discussed infrequently. Many IRA accounts are not that large. Requiring a trustee to oversee the management and distribution of the funds can be costly.
It may not be economical to require small accounts to remain in a trust. Before naming a trust as the beneficiary discuss your account sizes with your attorney and see if you can find an option that accomplishes your goals while proving to be economical for beneficiaries.
Some attorneys will draw up a document called a custom beneficiary designation that can offer more specific instructions than the standard beneficiary form that goes with your IRA or other retirement account.
Naming Children or Grandchildren as Beneficiaries
If you name minor children or grandchildren as direct beneficiaries, then in your will you need to name a guardian to manage the funds on their behalf until they reach the age of majority (18 or 21 depending on the state.)
If you have a special needs child, or adult child whom you don’t think should inherit the funds outright, you may wish to set up a special needs trust on their behalf.
If you are married and have stable adult children, the simplest and most economical solution can be to name your spouse as your primary beneficiary and your children as contingents.