Michigan Estate Planning – Who Should Be The Beneficiary Of Your IRA – Part 2

This post follows up “Part 1” , which dealt generally with IRAs and beneficiaries.

Most married people name their spouse as beneficiary.  That’s because:  (1) the money will be available to provide for the surviving spouse; and (2) the spousal rollover option can provide many more years of tax-deferred growth.

Also, if your spouse is more than ten years younger than you are, you can use a different life expectancy chart that makes your required distributions even less. (This lets the tax-deferred growth continue longer on more money.)

How does the spousal rollover option work?

If you die first, your surviving spouse can “roll over” your tax-deferred account into his/her own IRA, further delaying income taxes until he/she must start taking required minimum distributions on April 1 after age 70 1/2.

When your spouse does the rollover, he/she must name a new beneficiary, preferably someone much younger (commonly your children and/or grandchildren).  After your spouse dies, the beneficiary’s actual life expectancy can be used for the remaining required minimum distributions. The results of the tax-deferred grown, shown in the chart below, can be phenomenal.

For example, let’s say your grandson is 20 when he inherits a $100,000 IRA from your spouse. Over the next 63 years (the life expectancy of a 20-year-old), the $100,000 IRA can provide him with over $1.7 million in income!

Under current IRS policy, your spouse can do this rollover and stretch out the IRA even if you had started taking required minimum distributions before you died.

*****

TOTAL INCOME FROM IRA OVER BENEFICIARY’S LIFETIME*

Age 20, Life Expectancy 63.0 Years
Value of $50,000 IRA When Inherited by Beneficiary = $882,865
Value of $100,000 IRA When Inherited by Beneficiary = $1,765,731
Value of $500,000 IRA When Inherited by Beneficiary = $8,828,658

Age 30, Life Expectancy 53.3 Years
Value of $50,000 IRA When Inherited by Beneficiary = $526,612
Value of $100,000 IRA When Inherited by Beneficiary = $1,053,225
Value of $500,000 IRA When Inherited by Beneficiary = $5,266,128

Age 40, Life Expectancy 43.6 Years
Value of $50,000 IRA When Inherited by Beneficiary = $321,210
Value of $100,000 IRA When Inherited by Beneficiary = $642,421
Value of $500,000 IRA When Inherited by Beneficiary = $3,212,106

Age 50, Life Expectancy 34.2 Years
Value of $50,000 IRA When Inherited by Beneficiary = $201,067
Value of $100,000 IRA When Inherited by Beneficiary = $402,134
Value of $500,000 IRA When Inherited by Beneficiary = $2,010,671

* Assumptions: 7% annual return; only required minimum distributions withdrawn. Income subject to income taxes

 What Happens If My Spouse Dies First?

If your spouse dies first, and you don’t remarry, you lose the rollover option. This used to be a problem, because distributions after your death would still be based on your and your deceased spouse’s life expectancies. But now you can name a new beneficiary, and after you die the distributions will be based on the new beneficiary’s life expectancy.  This is what financial advisors commonly refer to as an “inherited IRA” or a “stretch” IRA.

What Are The Disadvantages Of Naming My Spouse As Beneficiary Of My IRA?

What are potential disadvantages of naming your spouse as beneficiary of your IRA?  First, your spouse will have full control of this money after you die and is under no obligation to follow your wishes (for example, if your spouse “rolls over” your IRA – making it her own – she will then name new beneficiaries).  This may not be what you want, especially if you have children from a previous marriage, or feel that your spouse may be too easily influenced by others after you’re gone.

Your spouse may mistakenly take a direct distribution, rather than a “roll over”, which would result in negative tax consequences.  In that case there are other disadvantages: If your spouse becomes incapacitated, the court could take control of this money, or it could be lost to your spouse’s creditors.

Finally, naming your spouse as beneficiary can cause your family to pay too much in estate taxes.   Everyone is entitled to an estate tax exemption.  But many married couples waste one exemption when they leave all their assets to each other. The marital deduction lets you leave your spouse an unlimited amount of assets when you die and pay no estate taxes at that time. But when your spouse dies later, he or she will only be entitled to one exemption, resulting in your family paying too much in estate taxes.

Estate taxes are different from, and in addition to, income taxes. When you die, your estate must pay estate taxes if its net value (including your tax-deferred accounts) is more than the amount exempt at that time. Currently in 2010 there is no federal estate tax, but it is scheduled to return in 2011 with a $1 million exemption and a 55% tax rate.

Estate taxes must usually be paid within nine months of your death. If money must be withdrawn from a tax-deferred account to pay the estate taxes, the result can be disastrous because income taxes must be paid on the money that is withdrawn to pay the estate taxes.

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2 Comments on “Michigan Estate Planning – Who Should Be The Beneficiary Of Your IRA – Part 2”

  1. MLM Says:

    That you for your informative discussion. I am fortunate. I have a wonderful son who is also knowledgeable about this subject.

    Sincerely,

    MLM

  2. MLM Says:

    Thank you for your informative discussion. I am fortunate. I have a wonderful son who is also knowledgeable about this subject.

    Sincerely,

    MLM


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