1. SPOUSE AS BENEFICIARY
The most common choice for a married couple is to select the surviving spouse as the designated beneficiary of an IRA or 401(k). When the IRA or 401(k) owner passes away, the surviving spouse has two choices with an IRA. He or she can receive payments under a one-life expectancy schedule or the IRA can be rolled over into his or her IRA. Because the payments under the IRA schedule are frequently double the required payments with the rollover, nearly everyone rolls over the IRA into his or her own plan. Assume that Harry Smith is the IRA owner and he passes away with Helen Smith as his designated beneficiary. Helen is age 68 when Harry passes away and rolls over the IRA into her plan. When Helen reaches age 70½, she must start taking required minimum distributions. The minimum distribution must be taken by April 1 of the next year and is just under 4%. Her distribution will steadily increase as she becomes more senior. Because Helen rolled over Harry's IRA into her IRA, she qualifies for the lower required minimum distributions under the uniform table. Helen often selects children or charities as designated beneficiaries. If you are in a community property state and plan to leave your IRA to a trust or other beneficiary that is not your spouse, then it is essential to obtain a written consent from your spouse. In many states, attorneys who prepare estate plans will frequently use a waiver if the spouse is not the designated beneficiary of an IRA.
For the surviving spouse, or in cases where there is a blended family, an IRA or 401(k), or any portion thereof, may be transferred to children. There are two typical methods for designating children as beneficiaries. First, if each child receives a fraction of the plan, then each child may take distributions based on his or her own life expectancy. Second, if there is a class designation with the IRA designated to a group of children or other heirs, then the age of the oldest beneficiary is used to determine the payouts. It is best with several children to allocate a fractional share to each child. The opportunity to use the separate share method is quite important because of the payout calculation method. If a 60-year-old child is the beneficiary of an IRA, then he or she may take distributions over approximately 25 years. The distributions would start at age 61 at approximately 1/25th or 4%. Using a method of subtracting one from the denominator each year, the payments would steadily increase until the entire IRA is distributed at approximately age 86. Does your child have to take the stretch payout? No, and frequently children do not. Many CPAs have indicated to the author that their clients have passed away and given the children an opportunity to stretch out the payouts. However, this plan is often not successful. Approximately one-half of the children take the distribution early, even though that means paying the income tax earlier and losing the benefit of the tax-free growth for the life expectancy of the child. Parents who wish to encourage lifetime IRA distribution for the child may choose to use a testamentary trust to hold the IRA and payout over the child's life expectancy.