Morningstar Magazine - April/May 2018 - 42

Strategies

Who Should Inherit Your Client's IRA?
And what if your client is an heir to one?

TAX WISE

Christine Benz

Deciding who your clients want to inherit
their IRA is straightforward. As with any other
asset, the best answer is whoever (or
whatever, in the case of charities) is most
deserving and would derive the biggest benefit
from the money.
Yet the logistics of leaving IRA assets to loved
ones, a trust, estate, or charity can get
complicated. Thus, before making plans for what
will happen to their IRA when they're gone,
be sure your clients understand the tax and other
implications. Also double-check that their IRA
beneficiary designations are in sync with any other
estate-planning documents-trusts and
wills-that they have drafted. Many people are
surprised to learn that what's specified in the
beneficiary designation will take precedence over
what's specified in the other documents.
Here's what your clients need to know before
leaving IRA assets to their spouse, other loved one,
charity, estate, or trust.
If the Beneficiary Is a Spouse
Spouses who inherit IRAs, unlike other people
who might inherit IRA assets, have the opportunity
to roll the IRA into an IRA in their own names.

This is particularly beneficial if the spouse who
inherits the IRA is significantly younger than
age 70 1/2 and doesn't need the money; he or she
will be able to delay required minimum
distributions until then, because the RMDs are
based on his or her own IRA assets, not the
decedent's. (If the IRA assets are Roth rather than
traditional, RMDs would not apply if the
assets are rolled over into a Roth IRA in the
spouse's own name.)

42

Morningstar April/May 2018

From a practical standpoint, most spouses who
inherit IRAs are past RMD age, so this opportunity
to delay withdrawals and preserve the tax
savings of the IRA wrapper isn't that big a deal.
In other words, if a spouse is near or at
RMD age, the spouse definitely won't need the
IRA assets during his or her lifetime, and
another loved one like an adult child would benefit
more from the money, there's not a strong
tax case for leaving the money to your spouse.
If the Beneficiary Is a Child or Other Loved One

Nonspouses who inherit IRAs can roll the
money into an inherited IRA, thereby stretching
out the tax-saving benefits over their own
lifetimes if they choose to do so. Yet as
Morningstar.com contributor Natalie Choate,
an IRA specialist, points out, very few
people take advantage of this provision,
either because they need the money imminently
or because the individual was not named
as a "designated beneficiary."
If your clients' goal is for a loved one to take
advantage of this stretch provision, make
sure that they have filled out the beneficiary
designation form, not just named the person the
beneficiary in their will. In addition, clients
should discuss their goals for a stretch IRA with
their adult child or other loved one, to clarify
this is what they expect him or her to do
with the assets. Finally, it's worth noting that
the future of the "stretch IRA" is in
question, given that so few individuals take
advantage of it.
While it might seem appealing to designate
young children or grandchildren as the
beneficiaries of an IRA, your clients should bear
in mind that minor children can't legally
manage those accounts on their own. If clients
don't take pre-emptive steps to establish

who will manage those assets prior to the
child reaching the age of majority, the court will
decide who will do it.
If clients would like to make a child the
beneficiary of an IRA, then they should specify
in their will the name of a custodian to
manage the child's financial affairs until he or she
reaches a specific age. The custodian can
be the same person as the child's guardian, or it
can be someone else. Alternatively, clients
could make a trust the beneficiary of their IRA;
their trust documents, in turn, can spell out
how that money is to be managed and distributed
to their heirs. (Below, I cover what happens when
trusts are the beneficiaries of IRAs.)
If the Beneficiary Is a Charity

There are a couple of key tax benefits-not to
mention emotional benefits-to leaving IRA assets
to charity. Not only will the charity receive
the assets tax-free, but your clients' estate will
also be eligible for a charitable deduction.
By contrast, if they name children or other heirs
as the beneficiary of the IRA, they'll pay
taxes when they take withdrawals from the
account, assuming it's a traditional IRA.
But while naming a charity (or charities) seems
like it should be straightforward, complications
can arise. One workaround is to name a
donor-advised fund the beneficiary of the IRA
(or a portion of it); clients would then need
to let the donor-advised fund sponsor know how
they'd like the assets distributed to the charities
of their own choosing.
If the Beneficiary Is Their Estate

This seems like the simple way out, but
naming a client's estate as the beneficiary of his or
her IRA-either via the will or on beneficiary
designation forms-is less desirable than naming
an individual or charity. That's because those
who inherit assets from an estate would be
required to take distributions from the IRA account
within a short period of time-either by
the end of the fifth year after the account owner's
death, if the deceased had not begun taking
RMDs, or in line with the deceased person's own
RMDs if he or she had already begun
taking them.


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