The Seven Deadly Sins of Beneficiary Designations - #2

Deadly Sin #2: Naming Your Revocable Trust / Estate Beneficiary­­­ for Roth IRAs & Traditional IRAs

Carefully consider your options when naming your primary beneficiary as either a revocable trust or estate for your Roth IRAs & Traditional IRAs retirement accounts.

Take Lorraine for example. Lorraine grew up during the Great Depression and was a thrifty saver. She would contribute the maximum percentage allowed to her employer’s retirement plan and would match each year what percentage her employer would match into her 401 (k) retirement account. On top of this, her husband Rick opened and contributed another $400 dollars a month, before tax dollars, to his traditional IRA as a supplement to their retirement.

Rick passed away at the age of 75, and Lorraine obtained control of his assets as his spouse. Here’s the kicker: Lorraine, now widowed, decided to name her primary beneficiary as her revocable trust. After accumulating over $1,000,000 in retirement assets between both Lorraine and Rick’s Traditional IRAs, she did not realize the tax implications that would occur from listing the revocable trust as the primary beneficiary.

Consequently, Lorraine’s daughters are required to withdraw the assets within 5 years. This resulted in a higher federal tax (between 30-40%) and state income tax bracket (up to 15%) and the inability to continue tax deferrals for Lorraine’s heirs. This mistake will cost her daughters a lofty tax bill close to $400,000 over a five-year period. At the time, Lorraine thought naming her revocable trust as the beneficiary would ultimately save her two daughters going through probate and the expense. If she had named the two daughters as primary beneficiaries, this would have allowed each daughter to continue tax deferral by stretching the payments over their life expectancy. Consequently, this would place each daughter in a lower tax bracket, and half of their inheritance would not be subject to Uncle Sam.
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