At your death, any assets remaining in your individual retirement account (IRA) will be distributed to your survivors. With effective estate planning, you can make sure the loved ones of your choice inherit your IRA funds in an efficient and tax-effective manner. If you do not make arrangements, your survivors will still inherit your IRA, but it will happen according to the government’s plan.
Your IRA paperwork includes a beneficiary designation form. You fill this form out when you establish an IRA, and you can update the form at any point during your ownership of the account. When you die, the beneficiary named on this form is the person who will inherit the assets remaining in your account. Provided you have designated a beneficiary and he survives you, the account funds will pass directly to him, without the need for probate. If you have not designated a beneficiary, or if your beneficiary dies before you, your account funds will become estate assets and will be distributed with the rest of your probate estate.
If you have a valid will, IRA funds without a valid beneficiary will be distributed through the probate process as directed in your will. One drawback to this arrangement is that your IRA funds are combined with the rest of your probate assets and become subject to your creditors, who must be paid before your beneficiaries can inherit your assets; in this case, your IRA may be dissipated before it can be distributed to your beneficiaries, leaving them a reduced inheritance.
The second drawback is that the Internal Revenue Service requires IRA funds to be distributed to an estate over a shorter time than it might require the same funds to be distributed to a named beneficiary. This limits the growth potential of your account and, since IRA funds are not taxed until they are distributed, this can translate into higher taxes for your loved ones.
If you die without a will, your IRA assets will still be subject to probate; however, they will not necessarily be distributed according to your wishes. Instead, state law will dictate which of your family members — usually your spouse, your children, or your parents — stand to inherit your property.
It is important to ensure that your beneficiary designations are up to date and compatible with the rest of your estate plan. An attorney can help you maintain a comprehensive estate plan and show you ways to maximize your beneficiaries’ inheritances.