Retirement

IRA Beneficiary

What is an IRA beneficiary?

An IRA beneficiary is an individual or entity, such as a trust or charity, chosen by an Individual Retirement Account (IRA) owner to receive all or a portion of the account's assets after the account owner's death.

Why are IRA beneficiary designations important?

Because IRA assets transfer to your designated beneficiaries, it is critically important to make appropriate beneficiary designations to ensure that:

  • Your IRA assets pass to your beneficiaries according to your wishes.
  • Your IRA assets avoid the potential delay and expense of probate.
  • Your beneficiaries have the opportunity to extend, or "stretch," the tax-deferred earning period of the IRA assets.

Like all financial considerations, designating beneficiaries should not be an isolated decision. Beneficiary planning should be part of an overall estate plan, crafted with the input of an estate-planning attorney and a tax advisor.

Example: Why it's important to keep designations complete and current

Maureen named her husband as the sole beneficiary of her Merrill Lynch IRA but neglected to name contingent beneficiaries. When her husband died, she forgot to name her children as the new beneficiaries of her IRA.


Under the default provisions of her IRA, distributions will be payable to her estate. As her estate's beneficiaries, her children may have to take the assets in a lump sum preventing them from extending or stretching the taxdeferred earning period of the IRA assets. In addition, Maureen would like to leave some of her retirement assets to her grandchildren to help defray their college expenses. But unless she names them as beneficiaries, the grandchildren may never receive the money.

What is a "stretch" IRA?

This is a distribution strategy that can extend the tax-deferred status of your IRA assets across multiple generations.1 For example*:

  • Assuming the account owner, age 54, rolls over $400,000 from his employer retirement plan into a traditional IRA and names his wife, age 48, as beneficiary. At age 70½, the account owner begins taking Required Minimum Distributions (RMDs).
  • He dies at age 85. His wife, age 79, then rolls over the assets in her husband's IRA to her own traditional IRA, continues taking RMDs based on her life expectancy and names her son as the new beneficiary.
  • When she dies at age 89, her 60-year-old son transfers the assets to an inherited IRA and continues taking RMDs based on his life expectancy.
  • After a 67-year "stretch" period, IRA distributions totaling $4,320,480 have depleted the account.

Stretch IRA

* This hypothetical example is illustrative only. It assumes a 6% annual compound return from the rollover until the account is depleted, that the account owner rolls over the account on January 1 of the year he or she receives the assets, that all distributions are taken on the last day of each distribution year and that all distributions are the required minimum amount as determined by IRS regulations. These amounts are not adjusted for inflation and do not reflect any state or federal income tax that may be due upon distribution. The projections are not a guarantee of future returns or investment performance and are not intended to replace the calculations that need to occur on a yearly basis for calculating actual RMDs for account owners or their beneficiaries. It also does not reflect the volatility that can occur in an equity-based account and assumes current tax laws remain in effect throughout the time period.

How should you select an IRA beneficiary?

Your Financial Advisor can work with your attorney and tax advisor to provide you with guidance on the many questions to consider when designating beneficiaries, including:

  • Who do you want to inherit your retirement assets? Your spouse, children or grandchildren? Other individuals and/or charities?
  • How do you want the beneficiary to receive the assets? Directly or through a trust?
  • Who do you want to inherit your assets if your primary designated beneficiaries predecease you?
  • What are the tax implications and distribution options for you and the beneficiary with each beneficiary strategy?

What are some beneficiary designation strategies?

Beneficiary designation strategies have an impact on how IRA assets are distributed.2 Some of these strategies are summarized below. For information on additional strategies, consult your Financial Advisor, tax advisor or attorney.

Strategy 1:
Naming your spouse as beneficiary

In addition to the alternatives available to a nonspouse individual beneficiary, a spouse beneficiary has certain additional distribution options. When an IRA owner dies, regardless of whether death occurs before or after the owner is required to begin taking distributions, a spouse who is the sole beneficiary may roll over the assets into his or her own IRA. This alternative allows the spouse to:

  • Name new beneficiaries.
  • Begin taking distributions based on his or her own life expectancy when he or she reaches age 70½ (using the appropriate life expectancy table from IRS Publication 590).

A spouse sole beneficiary of an IRA owner who dies before his or her Required Beginning Date (RBD) may defer starting life expectancy distributions until the year the account owner would have attained his or her RBD.

Strategy 2:
Naming a nonspouse individual beneficiary

A nonspouse beneficiary who inherits IRA assets may take distributions based on his or her own life expectancy (see the stretch IRA example on the first page). This alternative typically stretches distributions of a longer possible time, extending tax-deferred potential growth of the assets.

Other alternatives may be available. A five-year rule may apply if the account owner dies before his or her RBD. If the account owner dies after his or her RBD, the account owner's remaining life expectancy may be used if it is longer than the beneficiary's.

If the account owner lives in a community-property state, the owner must obtain his or her spouse's consent if the owner has not designated the spouse as primary beneficiary for at least half of the account.

Strategy 3:
Naming a trust as your beneficiary

The account owner can name a trust as the IRA beneficiary. In so doing, the account owner can help to guide the distribution of assets after their passing, or prevent a windfall inheritance to heirs. For example, the account owner may choose to set up a trust which could gift an annual amount from the IRA to their heirs over a longer period of time than might be achieved by naming their heirs as direct beneficiaries. Special rules apply as to how to name a trust as your IRA beneficiary

Naming a trust as beneficiary can help you accomplish special goals, such as:

  • Providing lifetime income to a spouse, with assets ultimately passing to children from a prior marriage.
  • Designating a custodian to manage assets for a child with special needs
  • Making charitable gifts while gaining tax benefits.

Strategy 4:
Multiple individual IRA beneficiaries

If the account owner names multiple individual primary beneficiaries, the life expectancy of the oldest primary beneficiary generally will be used for determining the payout period for distributions to all the beneficiaries when the account owner dies.

However, each beneficiary may create his or her own IRA, called an inherited IRA, after the account owner's death. If these separate accounts are established by Dec. 31 of the year following the year of the account owner's death, each inherited IRA owner then can take distributions based on his or her own life expectancy.

Many of the techniques discussed here can be used with an IRA or an employer-sponsored retirement plan such as a 401(k). However, many employer-sponsored plans impose additional requirements when the employee dies. For example, some plans require the beneficiary to take a full distribution within one year of the employee's death. Unless rolled over, such a distribution would result in the taxation of the inherited assets. Spouse beneficiaries can choose to roll over any inherited assets to their own IRA. Nonspouse beneficiaries can elect to roll inherited assets to an inherited IRA. Plans may also require spousal consent in writing to name a nonspouse beneficiary. On the other hand, traditional IRAs typically do not impose any restrictions beyond RMDs. (See Glossary) Roth IRAs are not subject to RMDs. Your Financial Advisor can help you set up an IRA that names beneficiaries as you wish, unless you live in a community-property state. (See Strategy 2)

How often should you review your beneficiary designations?

You should designations periodically and revise them to reflect changing circumstances, major life changes or updated goals.

What should your beneficiaries know?

You should talk to the beneficiaries of your IRA and make sure they know how the designation will affect them. After your death, they will have many decisions to make during an emotional period. You may want to involve your beneficiaries as you make your designation decisions. You also may want to schedule a meeting with your beneficiaries and your Financial Advisor to discuss your plans.

What are the beneficiary designation types?

IRA account holders may designate a primary beneficiary and then generally may designate a contingent beneficiary if they choose.

  • Primary Beneficiary: Upon your death, the account is divided among one or more living primary beneficiaries, according to percentages or dollar amounts that you specify.
  • Contingent Beneficiary: Upon your death, if there are no living primary beneficiaries, the account will be divided among one or more contingent beneficiaries, also known as secondary beneficiaries.

What are common beneficiary designations?

You can specify how your assets pass to primary and contingent beneficiaries with these common designations:

  • Single Beneficiary: Assets are distributable to one living beneficiary.
  • Multiple Beneficiaries: Assets are distributable to more than one living beneficiary, with either dollar amounts or percentages to each specified.
  • Custom Beneficiary: If you have specific wishes about how your assets should transfer, you may need to make a custom beneficiary designation. With a custom designation, you can describe your wishes on the beneficiary form in your own words or with an attorney's assistance. Some examples of a custom beneficiary include:

    All My Children: Leave your assets to each of your surviving children equally, including any children born or adopted after you execute your beneficiary designation. Descendants of your deceased children do not receive a share of the assets.

    My Descendants Per Stirpes: Leave your assets to your surviving children and, if applicable, certain surviving descendants of your deceased children. Each of your surviving children and lines of descendants of your deceased children with surviving individuals are allocated equal amounts. Amounts allocated to lines of descendants are divided equally among the individuals in the oldest generation and, if applicable, allocated to surviving descendants of deceased members.

    My Descendants Per Capita: Leave your assets in equal amounts to your surviving children and surviving individuals in the oldest generation of each line of descendants of your deceased children.

    Trust: Leave your assets to a trust you have established to be controlled by the trustee for the beneficiaries named in the trust. For example, a trust might benefit your spouse for his or her lifetime, with amounts remaining after your spouse's death going to your children.

    Charity: Leave your assets to a tax-exempt religious, educational, scientific or charitable organization.

What is a disclaimer?

A qualified disclaimer allows a beneficiary to refuse all or a portion of the inherited IRA, avoiding additional income and the tax on that income. A beneficiary may disclaim rights to an IRA to allow the assets to pass to less affluent family members or a charity, or to preserve assets for future generations.

A beneficiary who disclaims an IRA cannot dictate to whom the benefit will be paid. Once disclaimed, the payout will go to the next designated beneficiary, whether that beneficiary is primary or contingent. A qualified disclaimer effectively takes the disclaiming beneficiary out of the picture. Once made, an effective disclaimer is irrevocable. A disclaimer must be filed within nine months of the account owner's death and before any benefits of the disclaimed assets are accepted.

Example 1

Hector and Sylvia, both 76, expect to leave a sizable inheritance to their children. When Hector dies, Sylvia decides to disclaim his IRA so that their children who were named as contingent beneficiaries receive the money.

Example 2 

Frederico is the primary beneficiary of his mother's IRA, and her favorite charity is the contingent beneficiary. Since he is 55 and financially secure when his mother dies, Frederico decides to disclaim the IRA so that it can benefit the charity. That decision eliminates income tax liability and reduces the size of his mother's taxable estate.

These are hypothetical examples meant for illustrative purposes only.

How can your Merrill Lynch Financial Advisor help?

Your Financial Advisor can help you:

  • Evaluate your retirement income sources and the impact of different distribution strategies using analytical tools that consider such factors as taxes, inflation and rates of return.
  • Evaluate a stretch IRA in the context of your overall wealth management strategy.
  • Assist you with your beneficiary designations, including custom designations and other specific beneficiary arrangements, in consultation with your attorney and or tax advisor.
  • Help implement retirement solutions for you, drawing on the broad range of investment opportunities and resources available at Merrill Lynch.
  • Help keep your retirement income strategies up to date through periodic review.

Glossary

Five-Year Rule — If a retirement account owner dies before the required beginning date for receiving distributions, the beneficiary may distribute the inherited assets under the five-year rule. This rule requires that the assets be distributed by December 31 of the fifth year following the year of the retirement account owner's death. For some beneficiary types, such as charities and estates, this may be the only option available other than a lump-sum distribution.

Joint Life and Last Survivor Expectancy Table — If the sole beneficiary is a spouse who is more than 10 years younger than the account owner, then this table can be used. It provides a factor based on the age of the owner and the spouse in the distribution year.

Required Beginning Date (RBD) — April 1 of the year following the year the account owner turns 70½ and must begin taking RMDs.

Required Minimum Distribution (RMD) — The minimum amount that the account holder must take annually upon reaching age 70½. There is a 50% additional tax if you do not withdraw the required minimum amount or if you take less than the required amount. An RMD also is the minimum amount that a beneficiary must receive each year upon inheriting an IRA. Depending on the distribution option chosen, RMDs for beneficiaries are calculated based on the value of the account from the end of the prior year and the life expectancy of the beneficiary, the deceased account owner or, if there are multiple beneficiaries, the oldest beneficiary.

Uniform Lifetime Table — This table shows the life expectancy divisor that corresponds to the account owner's age in the current year.

HOW CAN YOU GET STARTED?

If you want your IRA assets to pass to your beneficiaries according to your wishes and to avoid the potential delay and expense of probate, ask your Merrill Lynch Financial Advisor for assistance in designating your IRA beneficiaries. Your Financial Advisor, who is committed to understanding your specific needs, can help you develop customized strategies that fit your goals, risk tolerance, investing style and time horizon.

The case studies presented are hypothetical and do not reflect specific strategies we may have developed for actual clients. They are for illustrative purposes only and intended to demonstrate the capabilities of Merrill Lynch. They are not intended to serve as investment advice since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances. Results will vary, and no suggestion is made about how any specific solution or strategy performed in reality.

Merrill Lynch and its Financial Advisors do not provide tax, accounting or legal advice. Any tax statements contained herein were not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state or local tax penalties. Please consult your own independent advisor as to any tax, accounting or legal statements made herein.

1 The stretch IRA strategy is designed for investors who will not need the accumulated assets in their account for their own retirement needs.

2 The consequences of designating particular beneficiaries (your spouse, other individuals, a trust, your estate or a charity) are the same, whether the beneficiaries are designated by the account owner or the IRA document's default provisions.

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