Beneficiaries supersede wills and trusts, so paying attention to them is a key part of estate planning. Giving thought to choosing the right beneficiary is particularly important with an IRA because there are significant tax consequences, points out John P. Dedon, a trust, estate and tax attorney at Odin, Feldman & Pittleman in Washington, D.C.
Dedon says if an IRA owner doesn't choose a beneficiary for his IRA, it becomes subject to the IRS' five-year rule. The person who inherits the IRA must take all the money out of the plan and pay taxes on it within five years of the death of the owner. If you name the person who inherits the money the beneficiary, then that person can allow his IRA inheritance to grow tax free for many years, taking only minimal distributions and tax payments over his lifetime. That definitely increases the value of your gift.
If you are planning to leave your IRA to an offspring who is a spendthrift or a spouse who might be tempted to cut children from your first marriage out of her will, you can make a qualified trust -- not a person -- your beneficiary. This allows you to combine the benefits of a stretch distribution plan with asset protection, Dedon says.
You don't have to be wealthy for this kind of estate planning to make sense. Even people leaving behind modest IRAs choose trusts to make sure their loved ones are protected and treated fairly. Setting up a trust isn't usually a do-it-yourself project, but the cost isn't prohibitive -- often less than $1,000.
At the very least, don't neglect to update the beneficiaries on your retirement accounts. Being nice to your ex is one thing -- leaving him your hard-earned savings is quite another.