Don’t Overlook Your Clients’ IRA Beneficiary Designations

Kevin Matz, CPA, Esq., LLM
Published Date:
Apr 1, 2016

The beneficiary designation forms for qualified retirement plans and individual retirement accounts (collectively, “IRAs”) are often overlooked in a client’s estate plan. But in many instances, the beneficiary designation forms will control more assets than the will itself. A client may have a very elaborate will or revocable living trust that contains highly detailed and carefully thought out trust provisions for managing and preserving wealth for children, grandchildren, and other descendants. But if the IRA beneficiary designation form provides that all property goes outright to children – rather than to trusts to be established under the client’s will or revocable living trust – it will override the will. The IRA will fail to link to these trusts, and the children will inherit the IRA outright - not in trust.         

With the exception of Roth IRAs, the most important tax attribute of IRAs is the fact that they generally represent a large bucket of taxable income that has not been previously taxed. From an income tax planning perspective, the name of the game is to “stretch out” the payment of the IRA as long as the beneficiary’s circumstances permit. To the extent that the IRA continues to hold assets, the income earned on the IRA will be income tax deferred, allowing tax-free compounding. In contrast, any distributions to the IRA’s beneficiaries result in immediate taxation as ordinary income, although it is exempt from the tax on net investment income under IRC section 1411.

The IRC recognizes that tax deferral is a very powerful financial tool that negatively impacts government revenues, and strikes a compromise by requiring that certain minimum annual distributions be made from IRAs, depending on certain age factors. If the “participant” - the person who establishes the IRA - is still alive, required minimum distributions can generally be deferred until after the participant has reached age 70½. In contrast, if the participant dies, required minimum distributions will often be mandatory beginning in the year immediately following the participant’s death. In addition, where the participant has died prior to age 70½ and the IRA is payable to the participant’s estate, the IRA will need to be liquidated - thereby subjecting the participant’s estate to tax - by no later than the end of the year on which the fifth anniversary of the participant’s date of death occurs. In this last scenario, however, annual distributions are not required.

This is where the identity of the named beneficiary in the beneficiary designation form is extremely important. All other things being equal, the three most desirable classes of beneficiaries of an IRA are the (1) surviving spouse, (2) young beneficiaries (including certain qualifying “see-through trusts” established for their benefit), and (3) charities.

A surviving spouse is the only beneficiary who possesses the ability to “roll over” an IRA and make it his or her own. By so doing, the surviving spouse can delay having to take any required minimum distributions until reaching the age of 70½, regardless of the age of the IRA participant at the time of his or her death. Moreover, when surviving spouses receive the required minimum distributions, a much more favorable IRS actuarial table applies to them than for any other beneficiary. In addition, surviving spouses can designate their own beneficiary upon their death for their rollover IRAs, and subsequent required minimum distributions span that beneficiary’s actuarial life expectancy, as based on IRS tables. Thus, it is often desirable to name one’s surviving spouse outright as the primary beneficiary of the IRA, rather than naming a trust for the surviving spouse’s benefit, which generally will not enjoy any of these tremendous tax benefits.

Young individuals can be very effective beneficiaries of an IRA because the required minimum distributions can potentially extend over their lifetime - possibly spanning several decades, depending on their age. Certain trusts for the benefit of young individuals - commonly referred to as “see-through trusts” and containing IRS-sanctioned provisions - can be integrated into the estate plan to allow the asset protection and management benefits of a trust to be interwoven with the beneficiary designation form. But this is where one needs to be extremely careful: If the beneficiary designation form has not been carefully crafted to serve as a “bridge” that links up to the see-through trusts established under the client’s will or revocable living trust, the necessary coordination will not occur.

Finally, the client’s charitable aspirations should be carefully integrated into the IRA beneficiary designation form. As mentioned, IRAs generally represent a bucket of taxable income that has not been previously taxed. Thus, assuming a combined 40% federal and state income tax rate, a $1 million IRA will effectively shrink to $600,000 upon distribution to non-charitable beneficiaries. However, if the beneficiary is a tax-exempt organization (such as a U.S. tax-qualified charity), the $1 million in the IRA will remain the same. So a well-structured estate plan for a client who wishes to provide for both charitable organizations and non-charitable beneficiaries, such as family members, would entail giving the IRA to charity and giving other assets, such as non-IRA brokerage accounts, to individuals. By so doing, the client’s total wealth passing to beneficiaries upon death will go much further than it otherwise would.

Kevin Matz, JD, LLM, CPAKevin Matz, CPA, Esq., LLM (Taxation) is the managing attorney of the law firm of Kevin Matz & Associates PLLC, with offices in New York City and White Plains, NY. Mr. Matz is a CPA (in which connection he is a past chairman of the NYSSCPA Estate Planning Committee), and writes and lectures frequently on estate and tax planning topics. His practice is devoted principally to domestic and international estate and tax planning and he is a Fellow of the American College of Trust and Estate Counsel. He can be reached by email at, or by phone at 914-682-6884.


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