MARCH 21, 2016 VOLUME 23 NUMBER 11
You have decided to create a revocable living trust, naming your oldest daughter as successor trustee. Your trust directs that, upon your death, $10,000 is to go to each of your grandchildren, $50,000 to the Good Intentions charity, and everything else will be divided equally among your three children. So what should you put on your IRA beneficiary designation?
You might already have recognized that we just served up a trick question. There is, sadly, not an easy and obvious answer — at least not on the basis of the information spelled out so far.
It is going to be hard to tell you the correct (or even the best) answer here, but let’s look at some of the options. As you consider them, you might want to have your IRA custodian’s actual beneficiary designation form at hand. Don’t have one with you? Not a problem: you can probably download the form. Most major financial institutions offer their forms online — here are forms for Vanguard, Fidelity, TIAA-CREF. Look for your IRA custodian before we move on. We’ll wait.
Here’s something we notice about your IRA custodian’s form: it isn’t terribly flexible. Want to designate two charities? You might need to attach a separate sheet. Want to try to leave dollar amounts (“up to the first $100,000”)? You might not be able to do it at all. But let’s still look at some of the options. For the moment, we’re going to assume that you do not have a living spouse — but we’ll come back to that later.
You could just leave the IRA to the trust. This has several advantages. It’s straightforward. It lets you make any other changes you want in the trust document, and you’ll never have to fill out the beneficiary designation form again. It automatically takes care of a batch of follow-up questions unaddressed on the beneficiary designation form (like “what happens if a beneficiary is under age 18?” or “what happens if one of my beneficiaries dies before me?”).
It should be said that there are some problems with naming a trust as beneficiary. For one, the named beneficiaries might have to take all their inherited IRA money out slightly faster than if they had been named individually. For another, you might be assured — again and again — that you “can’t” name the trust as beneficiary, or that you incur extra tax liability if you do (this is incorrect, but common, advice). You’ll need to arm yourself with enough understanding that you don’t succumb and make more changes later.
So how do you actually name the trust? The online forms we looked at tell you to put down the name of the trust (“The Jones Family Trust”) and its date. Check the appropriate box (is this a current trust, or one created under your will?). Leave blank the space for a tax identification number if your trust uses your Social Security number.
You could just leave the IRA to your children. Let your trust fund the $10,000 for each grandchild, and the $50,000 to charity. The IRA could just pass to your children. The good news: it’s pretty straightforward to fill out the form (just list the three children, put 33.33% as to each and, probably, check the “per stirpes” box to make sure that any deceased child’s share goes to his or her children). The bad news: any share of the IRA designated to your child with a disability, or a spending problem, or a greedy spouse — will go outright to that child. It might cause other financial problems, but that might not be an important consideration.
You could leave the IRA to Good Intentions. It turns out that IRAs are particularly good resources for any charitable inclinations you might have. Why? Because the charity doesn’t have to pay any income tax on the IRA proceeds. But you are leaving a flat dollar amount to the charity, rather than a percentage — and most of the beneficiary designation forms assume percentages. So you have to either create a personalized beneficiary designation (and hope your custodian will accept it), or adjust the amount you leave to the charity outside the IRA, or modify your estate plan every year or two as your IRA grows and shrinks.Still, this approach might make sense. How to carry it out? Just put the charity in as beneficiary. Ask them for their tax ID number (they’ll give it to you). And watch the IRA balance every year to make sure you’re leaving the right amount (not too little, not too much) to Good Intentions.
You could leave the IRA to your grandchildren. You’re planning on leaving a small amount to each grandchild anyway, and leaving it in an IRA for most of their lives would allow it to grow, tax free, for years. But they will have to withdraw small sums every year after your death, so it can actually complicate things (especially if they are under age, or not yet ready to manage their own funds).Want to use this approach? Just list each grandchild, with date of birth. Pay attention to new additions (by birth or adoption). Make a decision about step-grandchildren, and monitor familial relationships accordingly. Review your beneficiary designation every year or two.
But what about your spouse? We promised we’d come back to this. For most people, in most circumstances, it makes sense to name your spouse as the primary beneficiary. Most of the specific items we’ve listed here will fit under the “Secondary Beneficiaries” or “Contingent Beneficiaries” section of the form.Why is this important? You probably want the account to benefit your spouse first. You might need your spouse’s approval to make any other arrangement. There are significant income tax advantages a spouse has over other beneficiaries (well, most other beneficiaries). But everyone’s situation is different, so make sure you explore this with your estate planning attorney before changing the beneficiary designation.
This looks pretty easy, right? What could go wrong? Well, how about this, or this. Be careful out there. Are you our client? Let us help you with the beneficiary designation form. Not our client? Talk to your estate planning lawyer.