Guest Writers: Atty. Petter R. Johnson and Atty. Neil L. Cohen

Each January, and then again in the spring, financial institutions that hold your IRAs send you a Form 5498. When you get this form, take a minute to consider whether you have named the correct beneficiaries for each of your IRAs.

The most popular options are to name individuals or a trust. A less common but tax efficient option is to name charities. In most cases a “primary beneficiary” and a “contingent beneficiary” should be named.

For married couples with adult, competent children, a common beneficiary designation is to name the owner’s spouse as primary beneficiary and the children as contingent beneficiaries. This allows the surviving spouse to elect a rollover and the children to inherit the IRA and “stretch out” receipt of the IRA benefits over their life expectancies, therefore deferring the taxes due on these Inherited IRAs for as long as possible.

However, there may be tax or non-tax reasons for naming a trust as IRA beneficiary, as follows:

  • A child may be a minor, disabled person, addicted to alcohol or other substances, or simply incapable of managing and preserving the money.
  • A married person may want “QTIP trust” protection for the benefits (i. e. protection against his or her surviving spouse remarrying and naming the new spouse as IRA beneficiary or involuntarily losing the assets to the new spouse in a death or divorce proceeding).
  • Parents may wish to have the IRA benefits held in a “protective share trust” for the benefit of a child, to protect against loss in the event the child has creditor’s claims or is involved in a divorce.
  • IRA benefits may be needed in order to fully fund the estate tax sheltered “bypass trust” (i. e. if a married couple does not want to rely on portability to use both spouses’ estate tax exemptions).

If a trust is named as primary or alternate beneficiary of an IRA, special care must be taken in drafting the trust. Otherwise all of the IRA benefits must be withdrawn into the trust, and the income taxes on the IRA benefits must be paid within five years of the death of the IRA owner at the trust’s income tax rates. Through the use of a “circle trust”, which is a type of “look through” trust, the receipt of the benefits by the trust can be stretched out over the life expectancy of the oldest trust beneficiary.

Naming the correct beneficiaries for your IRAs can be complicated, so please seek the assistance of your CPA and/or estate planning attorney.

The law firm of Woodman & Eaton, P.C. founded in 1980, has a long history of assisting families and business owners with their estate, business and financial planning needs. Personal service and close relationships, resulting in uniquely designed estate and business succession plans, and effective and efficient administration of estates and trusts remain a hallmark of Woodman & Eaton’s Practice.

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