In my previous article, I provided high-level rules that IRA owners must consider when naming their IRA beneficiaries. I will use this article in the IRA quick reference guide series to answer questions that I encountered while dealing with actual IRA owners. Hopefully, these real-life situations will provide additional clarification, beyond the high-level overview in the previous article.
My wife and I have accumulated about $100,000 each in our Roth IRAs (RIRAs) that we do not foresee a need for over our future years in retirement. I was thinking we might want to hold these and perhaps use them to help fund college for our six grandchildren. Do you think that this is a good compared to using a 529 college savings plan?
I think it is an excellent idea over a 529 plan for several reasons. All contributions to a RIRA or a 529 plan are after tax. Some states even allow a deduction for contributions to their state 529 plan and are tax-free upon withdrawal. However, for 529 plans, the tax-free status only applies to certain qualifying educational expenses after adjusting for any scholarships and grants. A RIRA has no such limitations.
With qualified distributions from an RIRA, you have full discretion and flexibility to use the funds as you wish. With a 529 plan, your investment choices are limited to the investments offered by the plan. Conversely, a RIRA allows almost any form of investment. Another RIRA advantage occurs if you do not use the funds for your grandchildren’s college education. Your grandchildren might get scholarships, attend a military academy, attend college on the GI Bill or simply not attend college. In any of these cases, you do not have to change the beneficiary for the RIRA as you would with a 529 plan, Additionally, your withdrawals from the plan will not be for non-qualifying educational expenses, which you would have to declare as taxable income and pay the 10% penalty.
You can set up separate RIRAs for each grandchild, designate the grandchild as beneficiary to that RIRA and then do a direct rollover of a specific amount to each RIRA. This way, if you were to die before the grandchildren get to college, the grandchild will be the beneficiary of the RIRA and you would have an agreement with the grandchild’s parents – your children – to use the funds of the RIRA to pay for their college costs. Your grandchildren will have to take Required Minimum Distributions (RMDs) on the RIRA. However, due to their very long life expectancy, the amounts will be small and can easily be held in a custodial account until they reach college age. There will be no tax liability for the RMDs.
Choosing the RIRA option has one major risk that you must consider when making your decision. Once your grandchildren reach the state’s age of majority – 18 in most states – they will have full ownership of the RIRA and their custodial accounts to spend as they see fit. If you think this might be risky, a 529 savings plan might be a better option. With a 529 savings plan, only you – or your designated successor owner, if you die – control the funds’ amounts in the 529 plan, even when the grandchild is the beneficiary of the plan.
Is an IRA owner supposed to name his or her spouse as beneficiary to an IRA?
There is no federal law or regulation that requires an IRA owner to name his or her spouse or get the written approval of the spouse to name someone other than the spouse as the IRA beneficiary. This is different from the strict requirements for naming spouses as beneficiaries for employer-sponsored retirement required by the Employee Retirement Income Security Act of 1974 (ERISA). However, some states do require that the IRA owner names a spouse as the beneficiary, unless the spouse gives approval to name someone else or if there are other restrictions, such as how long the people have been married. You should check your state rules to determine which requirements you must follow.
The IRS Publication indicates that the beneficiary or beneficiaries must be determined by Sept. 30 of the year following the year of death. How can a decedent or their estate change the beneficiary or beneficiaries that already have been named before the IRA owner died?
Since most IRA custodians require that the IRA owner designate a beneficiary and often a contingent beneficiary, the beneficiaries will be known as of the date of death. However, if the IRA owner dies with no beneficiary and the beneficiary is not stated in the will, the state usually will use the state’s probate code to determine the beneficiary or beneficiaries. Some beneficiaries may promptly withdraw their percentage of the IRA while others may employ a disclaimer that puts their portion back into the estate. If some beneficiaries die in the interim, the executor of the estate must identify the remaining beneficiaries by Sept. 30 of the year following the year of death and transfer their names to the custodian. That way, the remaining beneficiaries can take all required minimum distributions from the IRA by the deadline of Dec. 31 of the year following the year of death.
What does it mean when the beneficiary statement on the IRA document says “to my grandchildren per stirpes”?
There are three possible beneficiary designations that most states will recognize and most IRA custodians will offer: (named beneficiaries) Per Capita, (named beneficiaries) Per Stirpes and (named beneficiaries) By Representation. If none of these is used with the designated beneficiaries, the default is usually Per Capital. Generally, if the beneficiary designation is Per Capita then a beneficiary who dies before the IRA owner will have their portion of the inheritance divided equally amongst the surviving beneficiaries. If the beneficiary designation is Per Stirpes and one or more of the beneficiaries predeceases the IRA owner, then that beneficiary’s portion will be divided equally amongst that decedent’s children. If the beneficiary designation is By Representation and if two or more designated beneficiaries predecease the IRA owner, then the all of the children of the deceased beneficiaries will receive an equal portion of the deceased beneficiaries portion of the IRA.
Please note that I am not an estate planning attorney. Therefore, if you have estate planning question, you should speak with the IRA custodian or competent legal counsel, as getting the beneficiary designations correct is very important, particularly with large IRAs and multiple beneficiaries. Otherwise, this might become fuel for family discord.
A close lifetime friend mentioned to me that she is naming me as the successor beneficiary to the Traditional IRA (TIRA) she has inherited from her mother who passed away last year. I have no idea what this means or if I am supposed to do something. Can you explain?
Yes, I can explain generally. When a non-spouse inherits an IRA, most IRA custodians will ask the beneficiary to name a successor beneficiary when they are retitling the IRA to include the beneficiary. Generally, the primary beneficiary may name anyone they wish as successor beneficiary, although this could vary by state. If you are designated the successor beneficiary and the primary beneficiary – your friend in this case – dies while there is still money in the inherited IRA, you would simply become the primary beneficiary of the TIRA. At a minimum, you would continue taking the minimum require annual distributions over the life expectancy of your friend had she not died. Additionally, as the successor beneficiary, the IRA custodian would request that you name a second successor beneficiary in the event you should die before the IRA has been fully withdrawn. However, remember that the minimum distribution rules are just the minimum. If you wish, you may withdraw larger amounts from the IRA over time or the entire remaining IRA balance in one withdrawal.
To get accurate information on being a successor beneficiary, you should contact the IRA custodian or legal counsel.
I hope these answers to some common situations regarding designating IRA beneficiaries help explain available options and what you can do in similar circumstances. This article concludes the section of this series that provides the main points that I wanted to share in this quick IRA guide. In my next article, I will provide some supplementary information about IRA administration and custodial issues.
Bruce Miller is a certified financial planner (CFP) who also is the author of Retirement Investing for INCOME ONLY: How to invest for reliable income in Retirement ONLY from Dividends and IRA Quick Reference Guide.