In my last post, I explained the importance of naming a beneficiary in your IRA, and how it can have major income tax and growth consequences for a child that is the named beneficiary. So now the question is about naming contingent beneficiaries, or backups so to speak. If you're thinking to yourself, it's not so much a question, really -- it makes good sense to name contingent beneficiaries in case the worst happens to your primary beneficiary, you're right. Most people quickly realize that they might as well name a contingent, as there's no downside to it (other than imagining for a second the awful prospect of having a child predecease you).
But, what many don't realize is that there can be tremendous upside to doing so, even if the child you named as your primary beneficiary outlives you. Wait -- you thought that a contingent beneficiary designation only kicks in if the primary beneficiary dies? Not true. A beneficiary has the ability to disclaim what is left to him (whether it's an asset left in a will or an IRA) and have it flow down to the next-in-line. To be clear, that ability is limited - specific documents must be filed and approved within limited time frames. But having that ability can be a powerful tool in estate planning.
Let's revisit the scenario of Rose, who thankfully by now is the named beneficiary of her mother's IRA. Rose is fortunate; she lives comfortably, has sufficient savings and has planned well for her own retirement. She is not in a situation where she is relying upon all of her mother's money. She also has two teenagers. Let's say that Rose's mother names her two grandchildren as the contingent beneficiaries of her IRA. When Rose's mother passes away, if Rose decides that she is comfortable with the idea of not receiving that IRA money herself, she can disclaim some or all of it, and the disclaimed portion of the IRA would then pass to her two children as contingent beneficiaries. This is where the concept of the IRA "stretch" comes into play -- the difference is that Rose's life is now bypassed in the calculation for the disclaimed amount. So instead of the IRA's required minimum distributions being stretched over 50 year-old Rose's life expectancy, they are now stretched over the life expectancy of teens. The translation: decades more of tax-free growth with smaller required distributions and lower tax bills on the distributions.
Is this to say that disclaiming an IRA is the right thing to do for everyone or that your grandchildren should be your contingent beneficiaries? Not at all. Every situation is different. But just having that option can be such a potent wealth-building tool that it underscores the need to treat IRAs as a very important aspect of estate planning, discussed in depth with your attorneys to maximize their potential value and to avoid any unintended consequences. Finally, you know the saying about the best laid plans...as a practical matter, despite everyone's intentions and the best legal minds at work, the effectiveness of these beneficiary designations often comes down to whether the particular financial institution holding the IRA and processing the beneficiary paperwork is going to treat those designations the same way you would have expected when the time arises. So I will say this: these institutions have inheritor services departments dedicated to handling estate work. Why wait to make use of those departments until there is an estate and then be faced with an unfortunate surprise once it is too late to change anything? You could make inquiries now, during the planning phase -- ask them how they would handle the different scenarios you are contemplating.
Peak Executor Solutions LLC does not render legal advice. The content of this article is for general information only. It is not intended to provide specific advice or recommendations for any individual.