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Who Should Be Your IRA Beneficiary?

The only way you can ensure that your IRA funds are passed along to whom you want in a tax-advantaged manner is to make sure that you put your intentions in writing with your IRA custodian.  You may have named an IRA beneficiary many years ago when you opened the account.  You should review this information periodically, but especially when your personal circumstances change.  On the other hand, if you do not name a beneficiary, the default beneficiaries spelled out in your IRA custodian’s document will determine who will receive the assets.  In some cases, these assets could go to your next of kin or even to an estranged spouse.

IRA beneficiaries are described generally as being a spouse or non-spouse.  Furthermore, your IRA beneficiary can be a person, a trust or a charity.  Each designation has particular pros and cons that you need to weigh carefully in order to make sure your wishes are executed tax efficiently.

Your Spouse as Beneficiary

Pro:    Your surviving spouse can make a tax-free rollover of your IRA into an IRA in his or her own name.  If a rollover is made, distributions from this account are taxed at your spouse’s rate and any required minimum distributions are calculated based on the spouse’s age.

Con:    Leaving your IRA to your spouse may mean that your tax-free federal estate tax exclusion amount, up to $1,500,000 in 2005, is not used.  If you have substantial assets, you should speak to an estate tax professional who can offer suggestions on how to reduce the tax liability for your family’s current and future generations.

Beneficiaries Other Than Your Spouse

Pro: If you leave your IRA to your children or grandchildren, your IRA may be given a second life that can provide your heirs with a lifelong stream of income.  In addition, the inherited IRA could continue to grow tax-deferred for many additional years, if the transfer of assets is handled properly.  All distributions are exempt from any 10% premature distribution penalty and, in any given year, the non-spouse beneficiary is allowed to accelerate distributions without penalty.

Con:  Non-spouse beneficiaries are not allowed to roll inherited IRAs into their own IRA.  If the IRA is not passed along correctly, taxes may be due immediately. While your non-spouse beneficiaries have the opportunity to defer income taxes on your IRA for many years, any estate taxes must be paid in cash no later than nine months following your death.  Minor children may not inherit an IRA until the age of majority.  A trusted custodian must be designated for the child, or else the local probate court will appoint someone to handle the account for the child.

A Trust as a Beneficiary

Pro:  Having a trust as a beneficiary ensures that the assets will be professionally managed according to your wishes.  A trust may provide you and your heirs with asset protection from creditors.

Con:  In most cases, designating your estate or your trust as a beneficiary entails the expense of professional asset management.  Also, your beneficiaries may be locked into the terms of the trust without the ability to manage the assets as they might choose.

Charities as Beneficiaries

Pro:  Leaving IRA assets to a charitable beneficiary may be more tax-efficient than leaving the assets to a person since these assets are not subject to estate taxes.

Con: Assets left to a charity will be totally removed from your family.

Selecting the right beneficiary for your IRA can be complicated.  Remember to look at your IRA assets in context with the rest of your estate before making any decisions   You should discuss the subjects of beneficiaries, wills and other estate matters with your tax professional to be sure your decisions are appropriate for your situation.

Will Davis is a Financial Consultant with Smith Barney located in Augusta, Ga. and may be reached at 706-724-2601 or 1-800-241-2401.

Smith Barney does not provide tax or legal advice. Please consult your tax and/or legal advisor for such guidance. Smith Barney is a division and service mark of Citigroup Global Markets Inc. Member SIPC.