Importance of Naming an IRA Beneficiary


Careful naming of IRA beneficiaries is critical. Merely putting a name on the beneficiary form is insufficient; a certain amount of thought, communication, and coordination is required to prevent loss of family wealth to taxation.

An IRA owner who wishes to pass on as much wealth as possible should carefully consider who should be named as a beneficiary. Wealth grows more quickly in the tax-free or tax-deferred environment inside an IRA. If some of your beneficiaries do not need the IRA funds for support, you should name the youngest possible designated beneficiaries to spread distributions over the longest possible time period. This minimizes RMDs, leaves more money to grow inside the IRA at its pre-tax rate of return and maximizes the amounts that can be passed on to heirs.

Should I make a trust a beneficiary?

Possibly. Naming an individual as beneficiary may lead to the following problems:

  • The IRA owner has no control over how the assets will be managed or distributed after his or her death;
  • The IRA owner cannot protect the assets from creditors after his or her death;
  • The IRA owner has no control over who receives the IRA payments after the death of the primary beneficiary;
  • The IRA owner has no control over how fast payments are made; and
  • The IRA owner has less certainty that RMDs will be made as required.

Naming a trust as beneficiary can solve all of these problems. Careful planning is necessary, however, to create the best possible result for the family and to avoid traps for the unwary.

There is a special rule under Reg. § 1.401(a)(9)-4, that permits an IRA owner to name a trust as beneficiary of his or her IRA and have the oldest trust beneficiary (and not the trust itself) treated as the designated beneficiary for RMD purposes if four requirements are satisfied:

  • The trust is valid under state law, or would be but for the fact that there is no corpus;
  • The trust is irrevocable or will by its terms become irrevocable upon the death of the IRA owner;
  • The beneficiaries of the trust can be identified from the trust instrument; and
  • Proper documentation has been provided to the plan administrator.
  • If the trust does not meet all four requirements, the IRA will be treated as having no designated beneficiary.

    It is almost always advisable to create a stand-alone trust specifically designed to be an IRA beneficiary rather than using an existing trust created for another purpose, such as a living trust. The goals of the IRA beneficiary trust and the living trust may be inconsistent and trying to combine them often leads to unintended results.