IRA’s (Individual Retirement Accounts) have two types of beneficiaries that you can choose picking the right one can mean higher taxes for your beneficiaries along with going through probate and higher costs to settle your estate.
A beneficiary is the person, persons, or entity that you wish to have inherit your assets in your IRA. The difference between “Beneficiary” and “Designated Beneficiary” is a Designated Beneficiary must be a living person who is named on the beneficiary form of the IRA. A trust or other legal entity cannot be a Designated Beneficiary.
The benefits of having a Designated Beneficiary are:
Distributions from inherited IRA’s can be stretched over a designated beneficiary’s lifetime, possibly allowing decades of tax-favored investment returns to be earned in the IRA.
The proceeds of the IRA pass directly to the designated beneficiary, bypassing complications and costs of Probate.
The idea of stretching your IRA can be significant in allowing the tax favored treatment of the asset. Here is an example, say Steve leaves $100,000 in his IRA to his estate which is not a living person. If Steve has not reached his RMD (required minimum distribution) when he died the proceeds must be paid out in Five years. If Steve reached his RMD, then the IRA can be paid out over his projected life expectancy at the time of his death. Now, if Steve gives his IRA to a designated beneficiary and that person or persons is living, then the proceeds can be paid out using that person’s life expectancy and for our example the life expectancy of a 30-year-old is much longer than the 5 or 15 years that the Estate would have thus saving money and allowing those funds to grow tax deferred over the course of the payout.
Finally, by having a Designated Beneficiary the IRA avoids Probate, if not then the monies go into the Estate and must pass through Probate which can cause delays in obtaining the monies to your heirs, costs associated with Probate can be a percentage of the assets in the Estate, loss of confidentiality as Probate is a public matter, and perhaps a contest against the Will as a disgruntled heir could challenge the Will. Multiple Beneficiaries, in the event that you leave your money to more than one individual the stretch period becomes the average of the two ages so if one person is 30 the other is 40 the average age is 35. Which would lower the years in the payout. Also note, if one of the beneficiaries is a charity which is a non-human then the other two beneficiaries would not be entitled to the stretch at all. There are work arounds with multiple beneficiaries that include charities so it is very important that you seek out professional advice from a CPA or a Tax Attorney.
In conclusion, an IRA can be left to an estate on purpose or by accident, and if in the event that you never completed the beneficiary form the Custodian of the IRA is required to pay the Estate by default. Make sure that you have updated your Will, reviewed your beneficiaries on your IRA’s, bank accounts, life insuance etc. Protect your heirs as it was your intention in the first place to do so.