Most people who are at or near retirement start thinking about how they would like to see their savings and assets passed on. Legacy planning is the process of expressing how those things will be transferred to the next generation. The preparation includes deciding how to handle the transfer of your Self-Directed IRA to your beneficiary or beneficiaries and thinking about timing and taxation, which will be critical parts of the process.
The balances in Self-Directed IRAs have been generally higher, partially because of the alternative assets, including real estate, which can generate both an income stream and capital appreciation. These accumulations make it all the more essential that you know your options and make your plans accordingly. Here some things to consider:
Make sure your beneficiary information is accurate and up to date
Whenever you open a Self-Directed IRA, you designate a beneficiary or multiple beneficiaries to inherit the funds in your account. You can name individuals or entities, such as churches, charities, or organizations, as your beneficiary.
You will use a beneficiary designation form when you open the account, but it’s essential that you regularly check to make sure the information on the form is up to date. Otherwise, your money may end up elsewhere from what you intended.
Your current information for each beneficiary should include:
- Full address, phone number, and email address
- Date of birth
- Social Security number or Tax I.D. for entities
- Relationship to the IRA account holder
If you have more than one beneficiary, you must decide how you want the money divided
If you have chosen to have multiple beneficiaries for your account, you also have to define how the funds will be divided. For instance, if you have three beneficiaries, you could share the assets equally, with each one getting one-third. But you could also give half to one and one-quarter to each of the other two.
The most common beneficiary designation form, called the “per capita” design, indicates that if any primary beneficiary dies before you, that portion of the account is to be divided between the other remaining primary beneficiaries. If there are no other primary beneficiaries, the deceased beneficiary’s share will be given to a successor beneficiary, if one has been named or appointed in the plan document by default.
The death of a beneficiary—along with divorce, births, adoption, or a new marriage—could affect your beneficiary instructions. That’s why it’s so important for you to review your designation form regularly. You might even consider obtaining help from a tax or legal professional whenever you initiate or change your beneficiary designation form.
Your beneficiaries will have distribution options
The IRS code allows your beneficiaries three options for receiving their distributions:
- The five-year rule
- Life expectancy payments
- Special rule for spouses
It’s worth noting that the choice that each beneficiary makes is irrevocable. That means even if the inherited account is transferred from one custodian to another, the distribution election remains unchanged.
Here are the details on each option:
- The Five-Year Rule
You could use this option if the Self-Directed IRA account holder did not start taking required minimum distributions (RMD) before they died. That means the date of death must have been before April 1st of the year following the time that the account holder turned 70 ½.
The beneficiary may choose to keep the assets in the account for five years. On the fifth anniversary of the Self-Directed IRA account holder’s death, the recipient must take the entire account as a taxable distribution. If any funds remain in the inherited account, they will incur a 50% “excess accumulation” penalty.
- Life Expectancy Payments
Using a standardized life expectancy table to determine how much must be distributed annually, your beneficiaries may withdraw all of the funds in the inherited account over time. The first life expectancy payment must be taken at the end of the year following the death of the Self-Directed IRA holder.
A special rule applies if the deceased account had already started taking RMDs and the beneficiary is older than the account holder. If this is the case, beneficiaries may use the deceased’s single life expectancy instead of their own age to calculate the life expectancy distribution.
Just the same as with the five-year rule, if a life expectancy payment is not distributed, that amount will be subjected to a 50% excessive accumulation penalty.
- Special Rule for Spouses
Spouses who are beneficiaries may choose to keep the assets in the original account, which will be renamed an “inherited account,” or to transfer the assets to their own Self-Directed IRA.
It’s good to communicate with your beneficiaries as you start legacy planning. That way you can let them know what their options will be so they can make informed decisions.