We meet our disciplined friend, whom we already know well, and he tells us: “I have already made a will and the other documents as you recommended. I assume that this establishes all beneficiaries, including those for my retirement accounts (IRAs).”
Although wills are very useful in naming and instructing transfer of certain assets, there are others where the beneficiaries are established by operation of law, that is, in accordance with what is established in their own documents, overriding the will and without the need to go through probate. Examples of these assets include life insurance policies, retirement accounts (IRAs), and corporate retirement plans (401k, for example). Given the relative size these assets have in most people’s estate, it’s worth understanding how they operate. In this article, we’ll look at traditional IRAs, including those where funding originated in a corporate-sponsored plan (Rollover IRA).
The law defines Designated Beneficiaries as those individuals named by the owner in the IRA documents. Such beneficiaries will receive the assets without going through probate court. The tax law also establishes advantageous rules as to how assets must be withdrawn from such accounts. Remember that IRAs have the advantage of deferring taxes until the time the funds are withdrawn, something that is very advantageous for beneficiaries as it will allow for better tax planning.
Within the Designated Beneficiaries category, there is a subcategory called Eligible Designated Beneficiaries (EDBs) which includes spouses, minor children, people with disabilities or chronic illnesses, and those who are up to 10 years younger than the deceased owner. For them, the law allows them to use their own mortality table and thus lengthen the time that assets will grow without taxes. The next category, Ineligible Designated Beneficiaries (NEDBs), encompasses all other natural persons for whom the period of distribution of assets may not exceed 10 years. This is still advantageous, but not as advantageous as in the case of EDBs. Finally, the term Non-Designated Beneficiaries (NDB) refers to legal entities (estates, certain trusts, charities, etc.) that do not have the same benefits.
To conclude, two things should be clear in this summary: first, the importance of formally naming beneficiaries, both primary and contingent, in such a way that the transfer of IRAs to intended beneficiaries can be ensured and without going through probate; second, those individuals who have been properly named, and qualify as designated beneficiaries (both eligible and ineligible), will have significant tax advantages when it comes to withdrawing funds from IRAs received as an inheritance.
In a future article, we’ll explain the differences between the payment options available to different types of beneficiaries.
Notice: The information provided herein is for educational purposes only. Portfolio Resources Group does not guarantee the accuracy of any tax advice, as we do not provide tax or legal advice. Consult a tax professional to ensure that recommendations are appropriate for your situation.