How would you like to turn your modest tax-deferred account into millions for your family? Depending on whom you name as beneficiary, you can keep this money growing tax-deferred for not only your and your spouse's lifetimes, but also for your children's or grandchildren's lifetimes. That can turn even a modest inheritance into millions.
Don't I have to use this money for my retirement?
When you reach age 70 ½ Uncle Sam says you must start taking your money out. (This is called your required beginning date.) But if you don't use all this money before you die, naming the right beneficiary can keep it growing tax-deferred for decades.
How much will I have to take out?
Calculating the amount you must withdraw each year (your required minimum distribution) is much easier now than it used to be. Each year, you divide the year-end value of your account by a life expectancy divisor from the Uniform Lifetime Table (provided by the IRS). The result is the minimum you must withdraw for that year. You can always take out more. For example, the divisor at age 70 is 27.4. If your year-end account balance is $100,000, you divide $100,000 by 27.4, making your first required minimum distribution $3,650. Each year the divisor is smaller, but it never goes to zero. Even at age 115 and older, the divisor is 1.9. "To recalculate or not to recalculate" is no longer an issue. Everyone now gets the benefit of recalculating their life expectancy.
Whom can I name as beneficiary?
You have five options: (1) your spouse (if married); (2) your children, grandchildren or other individuals; (3) a trust; (4) a charity; or (5) some combination of the above.
(1) Option 1: Spouse
Most married people name their spouse as beneficiary. And, in most cases, this will be your best option, because 1) the money will be available to provide for your surviving spouse and 2) it gives you the spousal rollover option.Also, if your spouse is more than ten years younger than you are, you can use a different life expectancy chart that makes your required distributions even less. (This lets the tax-deferred growth continue longer on more money.)
How does the spousal rollover option work?
If you die first, your surviving spouse can "roll over" your tax-deferred account into his/her own IRA, further delaying income taxes until he/she must start taking required minimum distributions at age 70 ½.
When your spouse does the rollover, he/she names a new beneficiary, preferably someone much younger, as your children and/or grandchildren would be. After your spouse dies, the beneficiary's actual life expectancy can be used for the remaining required minimum distributions. The results can be phenomenal.
For example, let's say your grandson is 20 when he inherits a $100,000 IRA from your spouse. Over the next 63 years (the life expectancy of a 20-year-old), the $100,000 IRA can provide him with over $1.7 million in income!
Under current IRS policy, your spouse can do this rollover and stretch out the IRA even if you had started taking required minimum distributions before you died.
Are there any disadvantages of naming my spouse?
Your spouse will have full control of this money after you die and is under no obligation to follow your wishes. This may not be what you want, especially if you have children from a previous marriage or feel that your spouse may be too easily influenced by others after you're gone.
(2) Option 2: Children, Grandchildren, Others
If your spouse will have plenty of assets after you die, if you have reason to believe your spouse will die before you, or if you are not married, you could name your children, grandchildren or other individuals as beneficiary(ies).
This will let you stretch out your account without the spousal rollover. Remember, after you die, the distributions can be paid over your beneficiary's life expectancy.
Are there any disadvantages to naming children, grandchildren or others?
Anytime you name an individual as beneficiary, you lose control. After you die, your beneficiary can do whatever he/she wants with this money, including cashing out the entire account and destroying your carefully made plans for long-term, tax-deferred growth. The money could also be available to the beneficiary's creditors, spouses and ex-spouses. And there is the risk of court interference if a minor inherits or if a named beneficiary is incapacitated. If any of this concerns you, consider using a trust.
(3) Option 3: Trusts
Naming a trust as beneficiary will give you maximum control over your tax-deferred money after you die. That's because the distributions will be paid not to an individual, but into a trust that contains your written instructions stating who will receive this money and when.
For example, your trust could provide income to your surviving spouse for as long as he or she lives. Then, after your spouse dies, the income could go to someone else. The trust could even provide periodic income to your children or grandchildren, keeping the rest safe from irresponsible spending and/or creditors.
While you are living, the required minimum distributions will still be paid to you over your life expectancy. After you die, the required distributions can be paid to the trust over the life expectancy of the oldest beneficiary of the trust.
The trustee can withdraw more money if needed to follow your instructions, but the rest can stay in the account and continue to grow tax-deferred. You can name anyone as trustee, but many people name a bank or trust company, especially if the trust will exist for a long period of time.
Are there any disadvantages to naming a Trust?
You will not be able to provide for your spouse and stretch out the tax-deferred growth beyond your spouse's actual life expectancy. That's because you must use the life expectancy of the oldest beneficiary of the trust which, in this case, would probably be your spouse.
Also, many trusts pay income taxes at a higher rate than most individuals, but this only applies to income that stays in the trust. (If you have a revocable living trust, this would only happen after you die.) Distributions from your tax-deferred account that are paid to the trust are subject to income taxes. And if the money stays in the trust, the higher tax rates would apply. But usually this is not a problem because the trustee distributes the money to the beneficiaries of the trust, who pay the income taxes at their own rates.
Finally, the trust must meet certain IRS requirements, including that it is a valid trust under state law.
(4) Option 4: Charity
If you are planning to leave an asset to charity after you die, a tax-deferred account can be an excellent one to use. That's because the charity will pay no income taxes when it receives the money. And the account will not be included in your taxable estate when you die, reducing the amount your family may have to pay in estate taxes.
(5) Option 5. Create Separate Individual Retirement Trusts for Each Beneficiary
If your living trust is named as beneficiary of your IRA, the life expectancy of the oldest beneficiary must be used for purposes of minimum distributions. If separate Retirement Trusts are created for each beneficiary, and the beneficiary designation names each trust to receive a share, the IRA can be split into separate shares upon death for each trust created. Because each trust has only one primary beneficiary, each beneficiary may use his or her life expectancy to calculate distributions and stretch out the IRA the same way that they could if named as an individual.
When can I change my beneficiary?
Under the new rules, you can change your beneficiary at any time while you are living, and the distributions after you die will be paid over that beneficiary's life expectancy.
In fact, now your final beneficiaries do not have to be determined until September 30 of the year after the year you die, which allows for some neat "clean-up" planning to be done after you're gone. For example, your spouse could "disclaim" some benefits so a grandchild could inherit. No new beneficiaries can be added after you die; you must have the right beneficiaries named on your account before then.
Some employer-sponsored plans (401(k), pension or profit sharing plans, etc.) have restrictions on beneficiary options. If your plan will not let you do what you want, rolling your money into an IRA will usually give you more options. If your money is in an IRA and the institution will not agree to your wishes, move your IRA to one that will.
Do I need professional assistance?
Yes, especially if you have a sizeable amount in tax-deferred plans and your estate is large enough to pay estate taxes. The rules are still complicated and loaded with tax traps and penalties. Also, any time you name someone besides your spouse as beneficiary, you need expert advice.