A common estate planning principle communicated by spouses who have children from prior marriages and relationships is, “If I predecease my spouse, I want my assets to be available for my surviving spouse’s needs, but when my surviving spouse dies, I want my assets to revert back to MY children.”

This can get complicated when the estate consists of Traditional IRAs, as many estates do. Let’s take the example of a Husband and Wife who each have two children. When H dies, his IRA is worth $1,000,000. In the year after Husband dies, Wife is 80 years old.

When it comes to income tax planning and IRAs, most recommend to keep the IRA balance as large as possible, allowing an IRA owner to earn investment income on deferred income taxes.

In this post we will discuss two strategies: (1) Naming the surviving spouse as the designated beneficiary of Husband’s IRA; and (2) Naming a trust (for the benefit of the spouse) as the beneficiary of Husband’s IRA.

When a surviving spouse is the designated beneficiary of an IRA, the surviving spouse’s ability to roll over inherited benefits to her own IRA gives her a powerful tax-deferring option, not available to any other IRA beneficiaries. If the surviving spouse holds the IRA as an owner, her Required Minimum Distributions (RMDs) are determined using the Uniform Lifetime Table under which her Applicable Distribution Period (ADP) is the joint life expectancy of the surviving spouse and a hypothetical 10-years-younger beneficiary. If she withdraws only the RMDs under the Uniform Lifetime Table, the IRA is guaranteed to outlive the surviving spouse. And it’s likely that the IRA will be worth more in the surviving spouse’s late 80’s than it was when she inherited it at age 80.

Let’s look at some numbers. Since Wife can use the Uniform Lifetime Table, her first required distribution the year after Husband dies (assuming a $1,000,000 IRA value) is $53,500 (5.35% of the IRA value). The next year her RMD is 5.59%. And the next year, 5.85%. If the investment performance of the IRA exceeds these distribution percentages, and she only takes the RMDs, the IRA will grow.

The downside, however, is that since Wife is treated as the owner of the IRA, Wife can name whoever she wants as the beneficiary of beneficiaries of her IRA. She could exclude Husband’s children by naming Wife’s children, or perhaps even Wife’s new spouse that she married after Husband died!

So instead of naming Wife as the designated beneficiary of Husband’s IRA, Husband considers naming a trust for Wife as beneficiary. The trust instrument might provide that RMDs go to Wife for her lifetime, but when Wife subsequently dies, trust assets revert back to Husband’s children. But since a trust was named as the beneficiary of Husband’s IRA, even if the trust qualifies as a “see-through” trust, RMDs after Husband dies will be based on the single life expectancy of the surviving spouse (Wife) which results in substantially less income tax deferral than would be available if the surviving spouse were named as the outright beneficiary and rolled over the benefits into her own IRA.

Let’s look back at the numbers. If a trust for Wife is named as beneficiary of Husband’s IRA, the first RMD when Wife is 80 (based on the same $1,000,000 IRA) will be $98,000 (9.8% of the IRA value). At age 81, the RMD will exceed 10% of the account value. And each year, the percentage will increase. If Wife lives long enough after Husband dies, the RMDs based on the required single life expectancy table will cause most of the benefits to be distributed to Wife outright which will defeat the purpose of trying to protect those IRA assets for Husband’s children.

So keep in mind that there are tradeoffs when it comes to naming beneficiaries of IRAs.

This post is for informational purposes only and does not provide legal advice. Please do not act or refrain from acting based on anything you read on this site. Using this site or communicating with Rabalais Estate Planning, LLC, through this site does not form an attorney/client relationship.

Paul Rabalais
Estate Planning Attorney
www.RabalaisEstatePlanning.com
Phone: (225) 329-2450…(read more)

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Second Marriage and IRA Beneficiary

Entering into a second marriage can bring about a range of financial considerations, including the designation of an IRA beneficiary. When it comes to managing your Individual retirement account (IRA), it is vital to understand the implications of your choices and how they will affect your loved ones.

Choosing a beneficiary is an essential step in establishing your IRA. It allows you to determine who will receive the funds in your account upon your death. For many people, their spouse is the obvious choice. However, those in a second marriage may find themselves wrestling with more complex decisions.

The primary concern for individuals in a second marriage is providing for their current spouse while ensuring their children from a previous marriage are not excluded. So, how can you navigate this delicate balance?

Firstly, consider the costs of a second marriage. In a blended family, there may be additional financial obligations, such as child support or alimony payments. These expenses can substantially impact your retirement planning. It is crucial to work with a financial advisor to evaluate your unique situation and determine the most effective approach.

One option widely used by couples in second marriages is creating a trust. This allows for the allocation of funds to both the surviving spouse and children from previous marriages. Trusts provide a level of control and protection that a simple beneficiary designation may not offer. They can help ensure that the funds are distributed according to your wishes and protect against potential disputes.

Another aspect to consider is the potential tax implications of leaving an IRA inheritance to your spouse. If your spouse is a beneficiary, they have the option to roll the funds into their own IRA account. This allows them to defer distributions and the associated taxes until they reach the age of 72. However, if they withdraw the entire balance at once or choose to take distributions without rolling over the funds, they will be subject to income tax.

Alternatively, you may choose to name your children from a previous marriage as beneficiaries. In this case, they will have the option to either take distributions over their lifetime or liquidate the entire account within ten years. By doing so, they will inherit the funds directly but will need to pay taxes on the distributed amount.

It is crucial to review and update your beneficiary designations after entering a second marriage. Failing to do so can result in unintended outcomes, such as inadvertently disinheriting your children or leaving your spouse without sufficient financial resources.

Additionally, communication is vital in ensuring that all parties involved understand your intentions. Discuss your decision with your spouse, children, and any other beneficiaries to avoid misunderstandings or conflicts later on.

Navigating the complexities of managing your IRA and making the right choices for your second marriage requires careful consideration and professional advice. Consult a financial advisor or estate planning attorney who can help you weigh the available options and create a strategy that aligns with your goals and priorities. Being proactive about your financial planning will provide peace of mind and a solid foundation for your future together with your spouse and loved ones from all walks of life.