What Happens to IRA Accounts Upon Death?

You are in charge of what happens to your IRA upon your death. By designating one or more beneficiaries, you determine how your IRA will be distributed. It is important to understand where to designate beneficiaries and what options are available to each while planning your estate, as improper designation could prevent your loved ones from carrying out your wishes.

You Must Designate a Beneficiary

First things first: you must designate a specific beneficiary or beneficiaries, and you must do so on the IRA beneficiary form. Your IRA custodian (the financial company where your IRA "lives") will provide you with this form when you set up the account and as needed any time after that point.

The IRA beneficiary form allows you to choose one or more persons or entities to inherit your IRA upon your death. You may ask that the account be divided equally or in share percentages. Each IRA has its own form, and you may designate different beneficiaries and portions for each.

A will cannot override a beneficiary form, so it is important to update your forms each time you update your will.

Different Options for Different Beneficiaries

There are three types of beneficiaries: spouses, non-spouse persons or organizations, and trusts. Each beneficiary has different legal options and requirements upon inheritance of an IRA. They also have different tax consequences.

Spouses

If you designate your spouse as a beneficiary, he can elect to treat your IRA as his own upon your death. This means that the IRS looks at your IRA as if he had always owned it. In a traditional IRA, required minimum distributions (RMDs) may be delayed or reduced. In a Roth IRA, your spouse can delay or minimize distributions and pass a larger portion of the assets onto your children or other secondary beneficiaries.

This option also allows your spouse to change the beneficiaries or convert a traditional IRA into a Roth IRA.

Other Persons and Organizations

You may designate your children, other relatives, other persons, or even organizations as beneficiaries. In these cases, the beneficiary must withdraw the money from the account. She has two options: withdraw all assets from the account within five years or take periodic payments over the course of her lifetime. The benefits and drawbacks of either option vary depending on the type of IRA and the individual's tax situation at the time.

Trusts

In certain circumstances, you may elect to set up a trust as the beneficiary of the IRA. The trust will be held to the same distribution rules as children and other beneficiaries, but the trust will hold the proceeds. This means that the trust will pay any tax due on the distributions and can invest and distribute them in any way you designate. This is especially helpful when the beneficiary is disabled or cannot otherwise handle his finances, as you may specify that distributions from the trust be used only for specific reasons.

An IRA is Part of Your Estate

The IRA beneficiary form is designed to allow the account to pass from you to your heirs without going through probate court. However, your IRA accounts will be included in your estate and may be factored in if your estate is large enough to be taxed. For specific advice regarding your situation, talk to a financial planner or estate attorney.

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About the Author

Nola Moore is a writer and editor based in Los Angeles, Calif. She has more than 20 years of experience working in and writing about finance and small business. She has a Bachelor of Science in retail merchandising. Her clients include The Motley Fool, Proctor and Gamble and NYSE Euronext.