What Happens to an IRA With No Beneficiary Designation?

What Happens to an IRA With No Beneficiary Designation

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When you establish your IRA, you have the opportunity to designate beneficiaries - -people who will receive the funds in your account after you pass away. And most married people name their spouse as beneficiary. But what if you and your spouse pass away in a common accident? Or your spouse passes away and you don't name a new beneficiary before you pass away?

When you die leaving no beneficiary for your IRA, the account is paid to your estate. There are two reasons that you don't want this to happen. First, if your IRA becomes part of your estate, then it has to go through probate before it can pass to your heirs. Second, having your IRA pass to your estate rather than to a designated beneficiary can severely limit the benefits that your heirs get from the account. Here's why:

Decisions, Decisions

When an IRA is paid to a designated beneficiary, that beneficiary can make the very wise choice to take only the required minimum distribution, or RMD, from the account each year. This is the minimum amount that, by law, your beneficiary has to withdraw. Your beneficiary's RMD is based on the IRA's balance and the beneficiary's life expectancy. By taking only the RMD each year which is also known as "stretching" the IRA, your beneficiary saves himself income taxes associated with a traditional IRA (because he's only taxed on the amount that he withdraws) and he preserves the account, allowing it to earn interest and grow over the years. Of course, he always has the alternative of withdrawing more than the RMD at any given time. So, it's important that you educate any beneficiary about the benefits of stretching an IRA, or talk to your estate planning attorney about options for ensuring that your beneficiary's inheritance is preserved.

Special Rules for Estates

If your IRA is left without a designated beneficiary, then it's paid to your estate. When this happens, IRS rules dictate that the account has to be fully distributed within five years. So, even though your heirs ultimately share in your IRA funds, it's likely that a good portion of those funds will be eaten up by income taxes. Plus, being distributed within five years significantly limits the life expectancy of your IRA, cutting short its growth and its benefit to your loved ones.

What to Do

So, as the owner of an IRA, make sure that you designate not just a primary beneficiary, but an alternate beneficiary as well. And, especially if you plan to leave your beneficiaries a significant inheritance using your IRA, talk to your estate planning attorney about options for making sure your loved ones get the maximum benefit from your account.

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