Practice Management
Naming an IRA Beneficiary: Spouse or Trust?
There are advantages and disadvantages to each approach. Your clients need to understand the difference.
This Practice Management article is intended for financial advisors only (registered representatives of broker/dealers or associated persons of Registered Investment Advisors).
Among married couples, naming the spouse as the IRA beneficiary is often the default choice.
"That's usually the case," says Glenn Frank, partner and director of investment tax strategy at Lexington Wealth Management in Massachusetts. "However, there are situations when it can make sense to name a trust as IRA beneficiary, with the surviving spouse as the primary beneficiary of the trust."
Naming the spouse outright offers several advantages. A surviving spouse is the only IRA beneficiary who can roll an inherited IRA into his or her own name, designating new beneficiaries, and perhaps delaying required minimum distributions (RMDs). If the survivor is relatively young and will need to tap the IRA, the account can remain as an inherited IRA so early withdrawal penalties won't apply; with no time limit, the survivor can wait until reaching age 59½, when the 10% penalty expires, to complete the spousal rollover.
Trust as Beneficiary
However, other concerns might outweigh the benefits of a spousal rollover. "There might be concerns that the surviving spouse will spend too much, too soon," says Frank. "I'm a big fan of a 'slow inheritance.'" The surviving spouse might be inexperienced in financial matters or have health issues that require protection from bad decisions.
"We also see married couples who have children from previous marriages," says Frank. "There may be an agreement that the spouse who inherits the IRA will name the other spouse's children as the beneficiaries, but the survivor's mind could change." If there are doubts as to how well an inherited IRA will be handled, the IRA owner can arrange for a trust to be the beneficiary.
Frank says that a reliable relative can be named as trustee, responsible for seeing that the surviving spouse has necessary, but not excessive, cash flow from the trust. "In some situations," he says, "a financial advisor could be a co-trustee, to see that the IRA's investments are managed appropriately for the trust's beneficiaries. Alternatively, the relative who will be the trustee can be introduced to the advisor and acquainted with the advisor's experience in working with the IRA owner."
Keeping the Peace
Although naming a trust as IRA beneficiary may be a logical move for some clients, logic doesn't always triumph in the real world. A spouse who won't be an outright beneficiary may not be overjoyed to hear the news. An IRA owner could set up the trust as IRA beneficiary without informing the spouse, but Frank doesn't recommend that approach.
"A surviving spouse might not be appreciative to learn that he or she has limited access to the decedent's IRA," says Frank. "It's better to discuss the matter while the IRA owner is alive. It can be a difficult conversation, but one strategy is to frame the trust designation as part of a plan to make things easier for the surviving spouse. 'I don't want you to have to worry. This relative and that advisor will help with the IRA; by using a trust, I'm doing what I can to make sure that you're comfortable.'"
Regardless of the client's intentions about informing the spouse, Frank says that a trust created to be an IRA beneficiary should be carefully drafted, to permit tax-efficient stretching of RMDs. "In addition," he notes, "such an arrangement should be included as one part of the client's overall estate plan."
—by Donald Jay Korn
Donald Jay Korn is a Financial Planning contributing writer in New York. He also writes regularly for On Wall Street.
A traditional IRA is a tax-deferred (Income whose taxes can be postponed until a later date; examples include IRAs and 401(k) plan earnings) savings plan available if you are under age 70½, and your spouse is also under age 70½. It is set up for your exclusive benefit, although your designated beneficiary(ies) may ultimately receive the proceeds. Traditional IRA contributions plus earnings, interest, dividends, and capital gains may compound tax-deferred until you withdraw them as retirement income. Amounts withdrawn from traditional IRA plans are generally included as taxable income in the year received and may be subject to 10% federal tax penalties if withdrawn prior to age 59½, unless an exception applies.
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