Do IRAs Have Death Beneficiaries?
An Individual Retirement Account is opened for saving funds designated as retirement income. An IRA has other benefits. Traditional IRAs offer income-tax deductions on contributions and defer taxes on growth. Roth IRA contributions are taxed, but growth and qualified Roth distributions are tax-free. Another benefit for IRA owners is the ability to name beneficiaries who inherit the balance of the account upon the owner's death.
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Avoid Probate
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Although an IRA is included in the taxable estate value, it is not subject to the probate process. An IRA owner names one or more beneficiaries and even includes contingent beneficiaries who receive the IRA value when the owner dies. Contingent beneficiaries receive the money if the primary beneficiaries are not alive when the IRA owner passes away. Avoiding probate allows beneficiaries quick access to capital if needed when closing out an estate. Inherited distributions from a Roth IRA pay no income taxes while traditional IRAs do. If the deceased person is already taking required minimum distributions, the beneficiary must take an RMD by December 31 the year following the owner's death. Roth's do not have RMD issues. Both remain subject to state and federal transfer taxes.
Spousal Beneficiary
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Most states require an IRA owner to name a spouse as the primary beneficiary. An IRA owner must name the spouse as a primary beneficiary unless the spouse signs a waiver releasing the inheritance. This means that a surviving spouse, in most states, can contest anyone else inheriting IRA funds if no waiver was signed. Surviving spouses inheriting IRAs have the choice of continuing the IRAs as their own, taking lump-sum distributions, taking distributions over five years or rolling money into a beneficiary IRA.
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Non-Spousal Beneficiary
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Beneficiaries who are not a spouse are more limited when inheriting an IRA. Non-spousal beneficiaries are not allowed to continue the IRAs as their own, but may take lump-sum distributions, five-year distributions or roll over the IRAs into beneficiary IRAs. The five-year distributions and beneficiary IRAs allow heirs to stretch distributions over time and reduce amounts added to adjusted gross income. These also allow heirs to allow IRAs to continue to grow tax-deferred. Remember that traditional IRAs have all distributions added to taxes. While Roth IRAs grow tax-free, they must still meet the five-year distribution period otherwise earnings are added to income tax. The five-year distribution rule means the IRA has to be owned for at least five years before taking tax-free distributions. Taking anything but a lump-sum distribution helps extend the time in meeting the five year rule.
Considerations
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IRA owners not required by state regulations to name surviving spouses as beneficiaries may name charities or even family trusts as beneficiaries. If a charity is named, the estate gets to reduce the amount of the taxable estate by the amount given to the charity. The charity does not pay taxes on the inheritance. If a family trust inherits an IRA, it will immediately liquidate the IRA and distribute funds according to trust orders.
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