The biggest consideration in estate planning for qualified plans and individual retirement accounts (IRAs) is determining the “right” beneficiary.

Different rules apply to qualified retirement plans and IRAs, and those rules affect an account holder’s right to name a beneficiary other than a spouse.

(Related: 12 Key Factors for Blended Families in IRAs, Qualified Retirement Plans

Under the Retirement Equity Act of 1984 (REA), a participant in a qualified retirement plan must obtain the written consent of the spouse in order to name a beneficiary other than the spouse.

The REA restrictions are inapplicable to IRAs because IRAs are not covered by the applicable parts of the Employee Retirement Income Security Act (ERISA) and are not included in Internal Revenue Code Section 401(a)(11).

1. The Surviving Spouse

In general, naming the surviving spouse as beneficiary (with disclaimer as an option in favor of contingent beneficiaries such as a trust that has credit shelter and qualified terminable interest property (QTIP) provisions) is an advantageous selection for several reasons.

First, it is simple and, at least in the case of a qualified retirement plan, mandated unless the spouse consents in writing pursuant to a certain required procedure to a different beneficiary. For both income tax and estate tax purposes, the selection of the surviving spouse usually provides the most tax deferral opportunities. This is because the surviving spouse, through a “rollover” or direct transfer from either a qualified plan or an IRA to a new IRA and treating that IRA as the spouse’s IRA, can get a “fresh start,” with an effectively “new” IRA and recalculate life expectancy annually.

A new IRA affords the spouse the opportunity to restart and “stretch out” the required minimum distributions to a later required beginning date (April 1 of the year following the year that the surviving spouse attained the age of 70½). This assumes that the surviving spouse is younger than the deceased spouse. The new IRA permits younger beneficiaries, e.g., the surviving spouse’s children, to use their own life expectancies for remaining distributions after the surviving spouse dies.

Additionally, if the surviving spouse is the recipient of the IRA benefits and if the deceased spouse’s estate is estate taxable, then the distribution outright to the spouse would qualify for the marital deduction.

Lastly, a surviving spouse can defer the minimum required distributions until December 31 of the year in which the deceased spouse would have attained the age of 70½. The surviving spouse also could be named as primary outright beneficiary but allow the surviving spouse to timely disclaim all or some part of the benefits to the contingent beneficiary, which could be a B (credit shelter) trust or even a QTIP-able trust.

Despite all of the benefits of naming a surviving spouse as the beneficiary of a retirement plan or IRA, many people do not wish to do this.

Brain maze (Image: Thinkstock)

(Image: Thinkstock)

There are a variety of possible reasons for this position, about which some clients are adamant. These reasons can include a desire on the part of the client to give those benefits to someone other than the surviving spouse, e.g., children of a prior relationship or charity, a desire to fully exhaust the account holder’s applicable exclusion amount at death and a desire to not “stack” these assets into the surviving spouse’s estate.

Sometimes, it is purely a matter of preferring their own selections of the ultimate recipients over those whom the surviving spouse may select, particularly in a blended family situation. Clients must be told about the advantages of naming a spouse anyway, but let them make that call in favor of an alternative beneficiary.

Since it is possible that the surviving spouse already has an IRA, or will create one after the rollover, it is a good idea not to commingle the funds from the rollover with the separate IRA funds of the surviving spouse. This is particularly true where the surviving spouse is trying to preserve the remaining assets from each IRA for different sets of beneficiaries, e.g., step-children and the surviving spouse’s own children.

As noted above, a surviving spouse may elect to treat the deceased spouse’s IRA as his or her own. Where the deceased spouse’s IRA or qualified plan benefit is transferred to a trust in which the surviving spouse is a beneficiary, there is no right to roll over the required minimum distribution even if the spouse is the sole beneficiary of the trust.

2. The Unmarried Partner

Another option as a beneficiary is a partner to whom the account holder is not legally married.

While this choice is as simple as naming a surviving spouse, this choice is not as attractive as naming a spouse because an unmarried person cannot defer distributions until Dec. 31 of the year in which the deceased account holder would have been age 70½ had he or she survived.

Additionally, the plan balance will not be sheltered by the estate tax marital deduction, which could expose the benefits to double taxation, i.e., income tax and estate tax. In fact, if the unmarried surviving partner is more than 37½ years younger than the deceased account holder, the plan benefits also could be subject to the generation-skipping transfer tax, although this will not be applicable where the partners are fairly close in age, which usually is the case.

Traditionally, only a surviving spouse could roll over the deceased spouse’s qualified retirement plan or IRA into a new IRA.

However, beginning with the effective date of the Pension Protection Act of 2006, a non-spouse beneficiary can roll over the deceased participant’s interest in a qualified retirement plan into a special form of IRA. Moreover, a non-spouse partner cannot roll over the deceased account holder’s IRA into a new IRA, as that right is limited to surviving spouses. An unmarried partner qualifies as a “designated beneficiary” for purposes of the required minimum distribution rules of the Code Section 401(a)(9) regulations, so that the five year rule (explained above) is inapplicable.

Baby (Image: Thinkstock)

(Image: Thinkstock) 

This selection assumes that the surviving partner can manage his or her own finances and has no need for creditor protection. If this selection is made and if the plan permits withdrawal of the entire benefit in a lump sum, the account holder’s desire to see the benefits stretched out over the partner’s lifetime could be thwarted if the surviving partner takes the benefit out in a lump sum.

Additionally, by naming a partner as the beneficiary, the account holder loses all dispositive control over who will receive the remaining benefit at the partner’s death. For these reasons, many account holders do not want to name a surviving partner as outright beneficiary, particularly in the blended family context.

3. The Children

Similar rules and considerations that are attendant to those of an unmarried partner apply. A child cannot defer distributions until Dec. 31 of the year in which the deceased account holder would have been age 70½ had the account holder survived.

Additionally, the plan balance will not be sheltered by the estate tax marital deduction, which could expose the benefits to double taxation, i.e., income tax and estate tax. There also is the fact that if the benefit is in a qualified retirement plan and if the participant is married, selecting children can only be done with the advance written consent of the non-participant spouse.

However, because, in the typical case, the children are in a generation below that of the account holder, greater opportunity to defer taking minimum required distributions generally exists for children vis-à-vis either a spouse or an unmarried partner, who usually are approximately the same age as the account holder.

Where there is a surviving spouse or unmarried partner, that survivor will not be entitled to any of these benefits on which to live, which may not be acceptable to the account holder. The same drawbacks that are applicable to spouses and unmarried partners apply to naming children as outright beneficiaries of plan benefits, i.e., no management or creditor protection.

—-Read Addressing Beneficiaries in Estate Planning on ThinkAdvisor.


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