NO LIVING BENEFICIARY ON AN INDIVIDUAL RETIREMENT ACCOUNT (IRA)?
When someone dies owning an IRA, one of the most fundamental questions is who was named as beneficiary. Even though many people hire lawyers to prepare wills and trusts they often fail to plan their IRA beneficiary designations. Even worse, many people attempt to prepare their own wills and trusts and not only create probate estate issues but compound the situation further by failing to plan their IRA beneficiary designations. For example, many people assume that naming heirs in a will is sufficient and that there is no need to duplicate those beneficiaries in their IRAs. This is far from the truth. You must have an IRA beneficiary designation to mirror your will beneficiary designation, if that is your intent.
How Could An IRA Account Fail To Name A Living Beneficiary?There are a myriad of reasons why an IRA account fails to name a living beneficiary. For example, Dad and Mom names the other as beneficiary on their IRAs. One of them dies and the survivor fails to change the beneficiary designation on the survivor's IRA. It is also common that when Mom or Dad dies the beneficiary survivor rolls the IRA proceeds into survivor's IRA or a new rollover IRA, but fails to name a living beneficiary on the survivor's IRA account. Commonly, forgetting to update estate planning information following the death of the beneficiary is one of the most common blunders when it comes to beneficiary forms.
When An IRA Doesn't Have A BeneficiaryWhen an IRA doesn't have a beneficiary, the financial institution will typically look at its own contract with the IRA owner to determine how that account will be distributed after the owner's death. The terms of these agreements vary widely. Sometimes, if there is a surviving spouse the surviving spouse is the default beneficiary; occasionally the account defaults to the children if the spouse is not alive. However, you can't count on the contract arrangement. Most custodial agreements provide that the account is payable to the account owner's estate. More often than not it is paid to the deceased's estate. There are two reasons why this result is unfortunate. 1. First, if the IRA becomes part of the deceased's estate, then it has to go through probate before it can pass to the deceased's heirs, either testate or intestate. 2. Second, having the deceased's IRA pass to the deceased's estate rather than to a designated beneficiary can severely limit the benefits that your heirs get from the account.
Special Rules For EstatesIn the event of your death, if your IRA is left without a designated beneficiary, it is typically paid to your estate. When this happens, IRS rules dictate that the account has to be fully distributed within five years. That means you're cutting the tax-sheltered growth of the plan woefully shorter than a beneficiary could have stretched it out if you had named one. Plus, if you had named your spouse as the beneficiary, your spouse could have combined it with an IRA in her own name. So, even though your heirs ultimately share in your IRA funds, it's likely that a good portion of those funds will be eaten up by income taxes. Plus, being distributed within five years significantly limits the life expectancy of your IRA, cutting short its growth - and its benefit to your loved ones.
Limited Surviving Spouse ExceptionWhen the IRA doesn't name a beneficiary, the IRS has held in a private letter ruling that the surviving spouse can't elect to treat the IRA has her own because it passed through the estate rather than going directly to her. In addition, the general rule is that even a surviving spouse who receives payments from the estate isn't allowed to roll over the distribution into his own IRA because the payment comes from the estate, not directly from the IRA. However, the IRS makes an exception if "the surviving spouse is the sole personal representative of the decedent's estate who must pay the decedent's IRA to himself as sole intestate beneficiary of the estate, and who, after such payment rolls them into an IRA set up and maintained in her name." If that's the case, the portion paid to the surviving spouse can be rolled into one of her own IRAs within 60 days without taxes or penalties to maintain the tax-sheltered growth.