Who should be the beneficiary of your IRA? The first answer for many people is their spouse. He or she can rollover an inherited IRA or Roth IRA and name new beneficiaries.
If you’re single (divorced, widowed, never married), you’ll probably name your child or children. After your death, they can stretch out tax-free distributions over their life expectancies. If your daughter inherits your IRA at age 59, for example, she can take out as little as 1/25th the first year, 1/24 the second year, and so on.
Leaving your IRA to your children might not be a great idea, though, if your children have ample income by then. They’ll have to take minimum required distributions and pay tax, if they inherit a regular IRA.
What’s more, the cash from minimum required distributions will pile up and may be subject to estate tax.
Therefore, your family may be better off if you leave your IRA to your grandchildren, for an extra generation of tax-deferred compounding.
At this point, you may not know whether to leave your IRA to your children or to your grandchildren. Fortunately, regulations the IRS issued last year offer a great deal of flexibility. You can name your children as beneficiaries and your grandchildren as contingent beneficiaries.
After your death, your children will have nine months to decide whether they’ll need the IRA. If not, they can disclaim the inherited IRA to the next generation.
Chances are, your grandchildren are minors, and more grandchildren may be on the way. Therefore, you may need to name a trust as contingent beneficiary, with your grandchildren as trust beneficiaries. The trustee will see that distributions really are stretched out over your grandchildren’s long life expectancies and a trust can provide that as-yet-unborn grandchildren will become IRA beneficiaries.
Suppose, for example, your grandson inherits your IRA at age 15. He will have a 66.8-year life expectancy for minimum required distributions. In Year One, only 1.5 percent of the inherited account need be withdrawn, and the other 98.5 percent can stay in the IRA.