IRA Contingent Beneficiary Rules
Both traditional and Roth individual retirement account structures avoid probate. The IRA owner has the right to not only name a primary beneficiary, but also name contingent beneficiaries should the primary beneficiary die before or with the IRA owner. Contingent beneficiaries have the same rules as primary beneficiaries.
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Primary vs. Contingent
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Primary beneficiaries are the first in line to get the IRA inheritance. An IRA owner can name one person or a list that splits percentages. Most states require a surviving spouse be the named primary beneficiary unless a signed wavier is provided. If a list exists, and something happens to one of the primary beneficiaries, the other primary beneficiaries split the remaining portion. For contingent beneficiaries to get the inheritance, all primary beneficiaries must be dead before the IRA owner or disclaim their rights to it. If primary beneficiaries are still alive and claiming the money, contingent beneficiaries get nothing.
Disclaiming an Inheritance
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Assume Mom inherited Dad's traditional IRA as the sole primary beneficiary on the account. The options to Mom are to continue the IRA, take a lump sum distribution, distribute the IRA over five years or roll the funds into a beneficiary IRA. Mom has one last option considering that she doesn't need the IRA funds to maintain her lifestyle: she can disclaim her right to it. This irrevocable decision is done by completing paperwork with the IRA custodian. If contingent beneficiaries are listed, the funds go directly there. If no contingent beneficiaries are listed, the funds go into the estate and dispersed as otherwise instructed by a will or trust. While this example uses Mom, any beneficiary can disclaim the IRA.
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Beneficiary Options
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Once a contingent beneficiary becomes the inheritor of the funds, he is simply referred to as the beneficiary. Just as Mom had more than one distribution option, most beneficiaries do as well. Any living person inheriting an IRA can take a lump-sum distribution, payouts over five years or roll the inherited IRA into a beneficiary IRA. A trust, estate or charity must take a lump-sum distribution. Only a surviving spouse can continue the IRA her own.
Preserving the Estate
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An IRA is valued as part of the entire estate for federal tax purposes. Any distributions from a traditional IRA are taxable even to beneficiaries. This means taking a lump sum or five-year cash out can significantly erode the IRA value after the owner's death. The beneficiary IRA allows the beneficiary to take minimum distributions each year based on his age. If the beneficiary is much younger, say a grandchild, the distributions are small enough to preserve the growth of the IRA for decades to come. Mom might disclaim the IRA if her granddaughter, Jenny, was named as the contingent beneficiary. This would preserve the tax-deferred growth through Jenny's lifetime and help her establish a strong financial foundation.
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