For Your To-Do List: Name Your IRA Beneficiaries Properly

Tina Haapala |

Sometimes it’s the simple things that end up costing us the most. For example, not properly filling out your beneficiary forms for your retirement accounts could cost your heirs thousands or even millions of dollars (well, millions if you die with a hefty amount left in the account—but I got your attention, right?).

A lot of times people don’t bother naming a beneficiary for their IRA. They figure they’ll get to it later, but later never comes. IRA accounts usually have some kind of default provision which, upon the owner’s death, will put it into their estate. If this happens before their starting required minimum distribution (RMD) date, the IRA would need to be emptied within 5 years of their death. If the account holder had already started drawing their RMD, those distributions would continue to the inheritor in the same amount, based on the previous life expectancy of the deceased.

If you have spent your lifetime saving and planning to the extent that you can leave money behind, you want that money to continue the long term tradition. Five years is not long term. Without designating a beneficiary, the long-term advantages, not to mention the interest, could dry up because the money had to be withdrawn early. And your heirs may end up with a heftier tax bill than they’d want.

This gets pretty complicated pretty fast, so let’s look at an example. Take Roth IRA owner, John Doe. At age 80, John has other accounts to use for his remaining years, so he wants his granddaughter, Sally, to have his Roth IRA when he dies. At 80, he has $500K in it. He figures it will grow, tax-free, for her entire life. She’s only 10. He writes up his wishes in his will and moves on.

John Doe should have taken another step: filling out the forms to make Sally the designated beneficiary of the Roth. Without that step, it is the estate that initially gets the Roth IRA money that is then transferred to Sally. If John Doe dies at 89 (assuming an 8% compounding rate), the Roth IRA balance would be around $1 million. If that money had to be distributed over a five-year period, it would defeat John’s goals. And while the distribution would not be taxable (it’s a Roth IRA, after all), now that the money is outside the Roth wrapper, the income from it would now be taxable.

If John would have designated Sally as the beneficiary on the Roth account form instead, the Roth could have grown, probably for another 63 years. She would have had to take distributions annually, but they’d begin very small, leaving the rest of the money to grow tax-free. That adds up. In this case to many dozens of millions of dollars.

Now, there are legitimate estate planning reasons for having an IRA pass through an estate, but they apply to very few people. For the rest of us, I think you now know that you should name a beneficiary—and a contingent beneficiary—to your retirement plan and IRA accounts.

Put that on your to-do list today.
This article was published under the title "Your IRA needs a beneficiary" in the Wichita Falls Times Record News on (01/22/2012)