Justin, I have already listed my wife as the death beneficiary on my IRA, but my financial advisor says I also need to consider adding a contingent beneficiary. What do you think? – Mitch
Mitch, Your financial advisor is right. Anytime you name a death beneficiary on any type of account or financial product, whether it’s a bank account, a life insurance policy, or an IRA, you should also consider what would happen if that death beneficiary were to die before you. In many cases, that means you should make a contingent beneficiary designation. This designation ensures that the financial institution has guidance from you as to what it should do if your primary beneficiary goes first.
However, when it comes to IRAs, there are some special considerations you must take into account when deciding how to handle your contingent beneficiary designation. You want to make sure that the account stays out of probate court, but that’s the easy part. You also want to provide as much protection as possible to those you plan to benefit from the IRA. This is especially true if your potential contingent beneficiary is a minor child, a disabled person, or someone who shouldn’t receive funds directly for some other reason.
If you’re not careful, though, your decision of contingent beneficiary can have major negative tax repercussions. The most common misstep on this point is to name a typical trust as a death beneficiary on an IRA. When an IRA passes to most typical trusts, the entire account is taxed at an accelerated rate.
There are safe ways to pass an IRA through a trust. In chapter six of my book, You Need A Plan, I touch on many options available when naming a contingent beneficiary on an IRA, and I highlight the benefits of using an IRA trust. Order your free copy at YourPlanMatters.com. And don’t forget, a no-charge strategy session is just a phone call away.