The individual retirement account (IRA) is a popular savings vehicle for retirement due to its tax advantages. Careful beneficiary planning can maximize these advantages, but one common mistake people make is naming their estate as the beneficiary of their IRA. This article will explain why it’s generally not recommended and discuss the distribution rules for different beneficiaries, including who can stretch the distributions over their lifetime and who must take all distributions within five or ten years.  Note the rules in this article are applicable to IRA owners who pass away in 2020 or later years.

The Downsides of Naming Your Estate as Your IRA Beneficiary

First, let’s look at why you might want to avoid naming your estate as your IRA beneficiary.

  1. Loss of Tax-Deferred Growth: One of the primary advantages of an IRA is the ability to grow your investment tax-deferred. When you name individuals as beneficiaries such as your spouse, they may have the option to stretch the required minimum distributions (RMDs) over their lifetimes, thereby maintaining the tax-deferred status of the IRA for a longer period.   Some other individual beneficiaries can defer the total distribution for up to 10 years.  
  2. Acceleration of Distributions: If an estate is named as an IRA beneficiary, the distribution rules can become more complicated and potentially unfavorable. The ‘stretch’ option is not available. Depending on the age of the IRA owner at the time of death, the entire IRA may need to be distributed within five years, or RMDs must begin immediately if the decedent was already taking RMDs. This forced acceleration could result in higher tax liabilities for the estate or its heirs.
  3. Probate and Creditors: When an IRA is payable to an estate, the funds become subject to the probate process, which can be lengthy, costly, and public. Additionally, these funds may also be accessible by the deceased’s creditors, which might deplete the assets before they can be distributed to the heirs.

The Secure Act and IRA Distribution Rules

The Setting Every Community Up for Retirement Enhancement (SECURE) Act, passed in 2019, changed the rules for inherited IRAs. Previously, most beneficiaries could stretch distributions over their life expectancies. The SECURE Act created a 10-year rule for most non-spousal beneficiaries. Under this rule, the entire balance of the inherited IRA must be withdrawn by the end of the tenth year following the year of the account owner’s death. However, the SECURE Act preserved the ‘stretch’ IRA strategy for a select group of beneficiaries known as “eligible designated beneficiaries” (EDBs). EDBs include:

  1. Surviving Spouses: The surviving spouse is still allowed to stretch the IRA distributions over their lifetime or rollover the IRA into their own IRA account.
  2. Minor Children: Minor children of the deceased can take distributions over their life expectancy until they reach the age of majority, at which point the 10-year rule begins.
  3. Disabled Individuals: A disabled individual, according to the IRS’s definition, can stretch the distributions over their life expectancy.
  4. Chronically Ill Individuals: Like disabled individuals, the chronically ill can stretch distributions over their life expectancy.
  5. Individuals Not More Than 10 Years Younger Than the Deceased: This group can also stretch the distributions over their lifetime.

By naming an EDB directly as a beneficiary, you can extend the tax advantages of an IRA, providing the beneficiary with potentially significant long-term benefits. In conclusion, while it may seem like a simple solution to name your estate as the beneficiary of your IRA, it can create a host of complications, tax inefficiencies, and potential legal issues. It’s essential to carefully consider your beneficiary designations and consult with a knowledgeable financial advisor or estate planning attorney to optimize your estate and retirement planning.

The Perils of Naming Your Estate as the Beneficiary of Your IRA
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