When opening a retirement account, the owner fills out a beneficiary designation form. Here’s a look at how to designate a beneficiary for an IRA account.
In this article:
- Who Is the Primary Beneficiary?r
- Who Is the Contingent Beneficiary?
- Important Processes in Designating More Than One IRA Beneficiary
- What Happens If the Primary Beneficiary Is the Spouse?
- What Happens If the Primary Beneficiary Is a Trust?
- What Happens If the Primary Beneficiary Is a Child or Grandchild?
- What Happens If the Owner Fails to Designate an IRA Beneficiary?
IRA Beneficiary 101: Important Things to Cover
Who Is the Primary Beneficiary?
Beneficiary Definition: Someone who legally derives advantage – or benefits – from a certain trust, life insurance policy, or will.
Once an investor can say that they are financially prepared, then inheritance is the next concern that needs their attention.
The primary beneficiary is the entity who is the first in line to receive the assets of the IRA if the investor passes away. Usually, the investor selects their spouse, children, or a trust as the primary beneficiary. Sometimes, the investor assigns more than one primary beneficiary, especially if they have more than one child.
Beneficiaries with varying degrees of relationship with the investor have different advantages and disadvantages on the movement of assets.
For example, a child or grandchild beneficiary cannot use an inherited IRA. A non-spouse beneficiary cannot make contributions to the account, nor can they roll over the assets to their own IRA.
On the other hand, a spouse who is also a primary beneficiary can roll over assets from an inherited IRA. Each kind of relationship also has different effects when the primary beneficiary passes away.
An investor can designate the system of inheritance if the primary beneficiary dies, like the per stirpes method or a system of equal distribution.
Per stirpes Definition: a system of distribution that allows each branch of the family to receive equal portions of the inheritance or estate.
Also, different kinds of retirement accounts have different taxable events. For example, the taxes and distributions from an inherited Roth IRA are different from an inherited Traditional IRA.
The IRS has a resource page for retirement beneficiaries.
Do note that the broker or custodian of an IRA account can have additional processes for transferring primary beneficiary status as well as automatic designations.
Who Is the Contingent Beneficiary?
Protecting the assets includes not only growing the value of the account but also ensuring that the assets transfer to the intended recipients as efficiently as possible.
The contingent beneficiary is the substitute of a primary beneficiary in case the primary beneficiary passes away before the investor.
Similar to the primary beneficiary designation, any entity can qualify as a contingent beneficiary. Many investors will place their children as contingent beneficiaries with the spouse as the primary.
The lack of a contingent beneficiary has a lot of negative effects, particularly a longer distribution schedule of assets as well as additional paperwork.
Some custodians and brokers automatically designate family members as contingent beneficiaries with the consent of the investor.
Most custodians ask the investor to complete pre-filled forms when the retirement account is created unless an employer does it for the investor.
These measures are put in place to safeguard the assets as well as facilitate the transfer of the IRA since the lack of a beneficiary vastly complicates things.
Important Processes in Designating More Than One IRA Beneficiary
If the investor only has one primary beneficiary, then the process is pretty straightforward. Once the investor designates who the primary beneficiary is, there is no need to assign distribution of assets at the time of their death.
On the other hand, if there are two or more primary beneficiaries, it is important to assign who gets how much of the retirement account. It is also important to set up a system that states who will receive the shares of a primary beneficiary who dies before the investor.
Regarding the distribution of shares, there are two common systems. The most common is equal distribution, with the second system specifying how much each person receives from the IRA.
Regarding the system of inheritance, if a primary beneficiary dies before the investor, there are two main systems available.
The first system is the per capita while the second is the per stirpes.
If the inheritance is in a per capita system, the surviving primary beneficiaries receive the shares of the deceased beneficiary in proportion to their shares.
For example, if a primary beneficiary dies and has four remaining beneficiaries with equal proportions, the four will share equally the remaining assets.
On the other hand, if the inheritance is on a per stirpes basis, the heirs of the deceased beneficiary receive the shares.
For example, let’s say that there are five beneficiaries with 20% shares each, and one beneficiary dies. The deceased beneficiary has two heirs, leaving only four surviving beneficiaries.
The new system will account for the two heirs. Now, there would be the four original beneficiaries at 20% each, and the heirs of the deceased, with 10% each.
What Happens If the Primary Beneficiary Is the Spouse?
Having the spouse as the primary beneficiary is easiest and most convenient for both the investor and the survivors. Under the eyes of the law, the IRS treats the spouse as if he or she is the principal investor.
The spouse can assume ownership of the inherited IRA as if he or she was the contributor. If he or she already has an IRA, the surviving spouse can elect to have two IRAs. Or, if the spouse finds the management of his or her original IRA satisfactory, he or she can roll over the assets to that account.
Another benefit comes from the required minimum distributions (RMD) compared to other entities. By rolling over the assets, the spouse can delay the RMD until they reach 70 and ½ years old.
This delay in distribution allows the assets to grow from compounded interest.
What Happens If the Primary Beneficiary Is a Trust?
Having a trust as the beneficiary can provide many ways to divide and distribute the assets to different beneficiaries.
The investor has more control, unlike the law which provides a rigid and straightforward asset division.
A trust is a great way to combine your IRA and estate planning. For example, a trust can make estate-planning easier when the investor has children from a previous marriage.
Making a guardianship under the trust for a minor can safeguard the misuse of the assets as well as ensure that the minor beneficiary receives the benefits.
However, a trust does not have the same benefits given to a spouse.
Depending on the laws that govern the trust, the beneficiaries may need to do an early distribution, which lowers the growth potential of the IRA.
Rolling over the assets to another IRA may need more work compared to a spouse doing the asset transfer.
However, a trust is still a popular option as a beneficiary. With a trust, the investor can control how the asset is spent. This limitation lowers the risk of irresponsible spending by the heirs.
What Happens If the Primary Beneficiary Is a Child or Grandchild?
There are fewer options with the children or grandchildren as beneficiaries.
Unlike the spouse as the beneficiary, the children cannot roll over the assets to his or her own IRA; instead, they can use the IRA as well as schedule the distributions.
Also, minor beneficiaries cannot manage the accounts. They should have a guardian control the assets until they reach the age of maturity, which varies from state to state.
Also, the IRA applies the required minimum distribution according to the age of the oldest child.
This system can create a lower monetary distribution for the younger children, who may receive early distribution penalties.
The children can also split the inherited IRA. By opting for this method, each beneficiary now has a new IRA and can avoid the early distribution penalties.
What Happens If the Owner Fails to Designate an IRA Beneficiary?
When there is a lack of primary or contingent beneficiary in the IRA, the IRA provider uses their bylaws. The contract usually specifies the order of priority on who becomes the beneficiary by default.
Usually, the spouse comes first in the list. In the absence of a spouse, the IRA can choose who becomes the default beneficiary.
Don’t forget to download, save, or share this handy infographic on how to designate your IRA beneficiary for reference:
Check out this video on how to designate your IRA beneficiary:
Having beneficiaries, primary and contingent, can streamline estate planning. Investing not only concerns itself with growing assets but also efficiently distributing them.
Assigning a beneficiary is as easy as filling out the form from the IRA provider.
An IRA without a beneficiary is incomplete and inefficient. Solve this issue as early as possible, and you can start prioritizing the growth of assets.
For more resources and information on IRA investment strategies, visit insideyourira.com!
What are some ways you are preparing for the security of your beneficiaries? Share your strategies with us in the comments section below!