The Seven Deadly Sins of Beneficiary Designations - #6

Deadly Sin #6: Do Not Name a Child Over a Spouse as a Beneficiary

For your IRAs, do not list your primary beneficiaries as your children over your spouse or partner. Obviously there are situations where this could apply, but in most cases this is not a plan you will want to consider for married couples, especially when there is a large age gap.

For example: take Lisa, who is in her late-fifties and Richard, who is in his late sixties. Rich has a $1,000,000 IRA and is living quite comfortably, while Lisa is still working and receiving income. Lisa loves her job and does not see herself retiring until 65. She has accumulated a nice little nest egg for retirement and is projected to have over $2,000,000 in retirement assets by the age of 65. Both Lisa and Rich spoke with their financial advisor and decided to take a small $200,000 annuity held within Rich’s traditional IRA and earmark these specific assets to be split between their children. Rather than titling the beneficiary to Lisa, the couple decided to give the annuity to their two boys, Jake and Josh, who are in their late twenties and early thirties.

Rich passed away, leaving the annuity to his children. Although the children’s’ inherited IRAs are not subject to the 10% penalty, Jake and Josh are required to take minimum distributions based on each of their life expectancies. This limited their ability to let the assets compound and continue as tax deferrals. Also, the IRA custodian or trustee will have to report these RMDs as "death distributions” on their IRS 1099-R. Failure to take RMDs will result in an excise penalty tax of 50% on the amount which should have been distributed.

In this case, Lisa and Rich should have named their two kids as contingent beneficiaries and Lisa as the primary beneficiary. The assets would then continue to compound and grow tax deferred. Lisa would not need to take required minimum tax distributions until 70 1/2. Once Lisa passed away, Jake and Josh could stretch these payments over their life expectancy and continue tax deferral.