If an estate is named as a beneficiary, then the ability to stretch the IRA over the life expectancy of a designated beneficiary is lost.
Ives discussed a 2003 private letter ruling from the IRS that allowed an inherited IRA where the estate was the original beneficiary to be split up so that a non-spouse beneficiary could receive a one-third interest in the account. But doing so eliminated the non-spouse beneficiary’s ability to stretch RMDs over their lifetime.
“If an estate becomes the beneficiary, then the IRA becomes a probate asset,” said Ives. “It has to go to probate and there are estate fees and court costs incurred if you name the estate as the beneficiary.”
Naming a trust as a beneficiary does not always avoid the loss of the stretch strategy, said Ives. A 2012 private letter ruling from the IRS confirmed that, in a case where an IRA willed to a trust and then divided among the IRA owner’s four children, the trust was not technically a designated beneficiary. The IRS ruled that the ability to stretch the account was lost.
IRA Beneficiary Choices
Brenner explained that there are three different kinds of beneficiaries: charities, spouses and non-spouses.
“A charity is a great traditional IRA beneficiary, because most of the time distributions from a traditional IRA are going to be taxable. But a charity does not pay income taxes,” she said. “This is a good topic to discuss with clients. They want to think about revisiting charitable requests within their will.”
However, using a charity as a beneficiary may also eliminate the possibility of using the stretch IRA strategy, said Brenner. If an account owner wants to leave part of their IRA to charity, advisors may want to split the account up while they’re still alive so that any designated beneficiary could still use the stretch, he said.
An account owner could also name a charity as a secondary beneficiary to the account, said Brenner. That way, the primary beneficiary could disclaim any portion of the account they wish to go to the charity.
When a spouse is named as an IRA beneficiary, they have the opportunity to exercise a spousal rollover where they inherit the funds and roll them over into their own IRA. This is most often accomplished with what’s known as a “60-day” rollover, said Brenner.