The Plot Thickens: Designated & Non-designated
Beneficiaries
There is a significant difference in the tax treatment of inherited IRAs for designated
versus non-designated beneficiaries. This of course, comes into play after the IRA
owner dies. However, the IRA owner can make changes to his/her IRA beneficiaries
before death – and avoid losing the long-term benefit of tax deferral on the IRA
funds.
Part 1: Designated Beneficiaries
A Designated Beneficiary is a named individual- a person, as opposed to your estate, a
charity, or trust. The Designated Beneficiary must be named on the most recent IRA
Beneficiary forms. Your named beneficiary may be your spouse or anyone else. The
“anyone else” category is termed a non-spouse beneficiary in IRA lingo, and receives
lesser rights or benefits to inheriting an IRA than a spouse is entitled to receive.
A non-spouse beneficiary who is named as primary beneficiary is any individual, other
than the IRA owner’s spouse. This includes same-sex partners, friends, children,
relatives.
Both spouse and non-spouse primary beneficiaries have the option of taking a full or
partial lump sum distribution and paying income taxes on the amount withdrawn.
Both also have the option of stretching the retirement distributions over their own
lifetimes and thereby, continuing the tax-deferred benefits of the account.
Flashing warning Light! Many corporate retirement plans (401(k), 403(b), etc.) do
not permit the beneficiary of a deceased employee to take the lifetime stretch of
retirement distributions. The Plan Summary Document will spell out permitted
distribution methods for their deceased employees are typically a five year payout or
immediate full payout. In either case, you lose the benefit of tax deferral and must
come up with funds to cover the income taxes.
DISCLAIMER The information presented here is general and brief in order to
provide the highlights of each subject. IRA regulations are very complex and IRAs, in
many respects, are subject to different tax laws than income tax and estate tax. To
make an appointment for a consultation on this or other issues, please e-mail a
summary of your question to magrier@suddenlink.net
Part II: Non-designated Beneficiaries
A Non-designated Beneficiary is usually an entity, not a person. Since it is not a
person, it does not have a life expectancy which is the basis of stretching retirement
distributions over the beneficiary’s lifetime. Typical examples of non-designated
beneficiaries are charities, trusts, and estates. Non-profit status charities do not pay
income tax anyway, but the deceased’s estate (as IRA beneficiary) must pay federal
and state income taxes on the full value of the IRA and, of course, lose all future tax
deferral of those funds.
Trusts, as Non-designated Beneficiary of an IRA are more complex. A trust may
be necessary in the case of a minor child, an incapacitated individual, a special needs
beneficiary, as a few examples. Establishing such a trust requires an estate planning
attorney with expertise in IRA distribution rules. If the trust does not follow certain
guidelines, it could result in accelerated taxation of the IRA funds.
DISCLAIMER The information presented here is general and brief in order to
provide the highlights of each subject. IRA regulations are very complex and IRAs, in
many respects, are subject to different tax laws than income tax and estate tax. To
make an appointment for a consultation on this or other issues, please e-mail a
summary of your question to magrier@suddenlink.net