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I am in the process of updating beneficiaries to 401(k), traditional IRA and Roth accounts. The current primary beneficiaries are (in some cases) my spouse and (in some other cases) my children. Does it make a difference taxwise who my beneficiaries are?

--SirTas
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SirTas: "I am in the process of updating beneficiaries to 401(k), traditional IRA and Roth accounts. The current primary beneficiaries are (in some cases) my spouse and (in some other cases) my children. Does it make a difference taxwise who my beneficiaries are?"

Assuming you mean only from a tax perspective, yes, because a Spouse can roll IRAs inhereited from his/her spouse into the first sposue's own IRA; no other beneficiary can do that.

Ignoring all the issues about leaving sufficient funds for the surviving spouse.

Regards, JAFO
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I am in the process of updating beneficiaries to 401(k), traditional IRA and Roth accounts. The current primary beneficiaries are (in some cases) my spouse and (in some other cases) my children. Does it make a difference taxwise who my beneficiaries are?

I would ignore the tax situation and focus on what you really want to accomplish with any assets that survive you. Your beneficiaries have no obligation to share amongst themselves. So any jiggering you do for tax purposes could interfere with your wishes.

As to direct tax consequences, there aren't any with regard to inheritances at the federal level. Some states still have an inheritance tax assessed against the beneficiaries, but spouses and direct descendents are usually exempt.

The only possible issue with leaving too much to your spouse is that you might push the total assets of the second-to-die over the estate tax threshold. Of course, from where we stand today, who knows what will happen with regard to estate tax.

Ira
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...Assuming you mean only from a tax perspective, yes, because a Spouse can roll IRAs inhereited from his/her spouse into the first sposue's own IRA; no other beneficiary can do that...

This is my understanding; please correct me if I'm wrong:

Regarding income tax on an inherited traditional IRA:
- If the spouse inherits, s/he can roll it into his/her own IRA, and have no tax due at the time of rollover, but will still have to pay income tax on distributions later on, when the money is withdrawn.
- If the children inherit, they have to pay income tax when they inherit.

So this looks to me like a pay now vs. pay later scenario, as opposed to pay more vs. pay less. And for an inherited Roth IRA, it shouldn't make any difference, since no income tax would be due regardless of who inherits or whether it stays in an IRA.

Estate tax is a different animal (from income tax), and although estate-planning attorneys can set up trusts for married couples so that the 2nd-to-die's exemption isn't lost, this maneuver is done with house, savings accounts, and other non-IRA assets. An IRA can't be put into a trust anyway, and given the spousal rollover option, the recommendation is to name the spouse as primary beneficiary and the trust as contingent.

With a nod to Ira's comment of considering objectives other than tax minimization, I am primary beneficiary of my husband's IRA's, but the children are primary beneficiaries of mine. Because (1) he has a pension with a survivor's benefit that's less than 100%, so he won't need my IRA as much as I'd need his, and (2) if everything goes to him, and he remarries and has more children, it's possible my children would get nothing. Very highly unlikely, but just in case, I feel better knowing they'll just get something right away.
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Estate tax is a different animal (from income tax),

If estate tax is a concern, converting a traditional IRA to a ROTH IRA may be useful to decrease estate taxes. The income tax is "pre-paid" removing it from the estate.
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YewGuise:

<<<...Assuming you mean only from a tax perspective, yes, because a Spouse can roll IRAs inhereited from his/her spouse into the first sposue's own IRA; no other beneficiary can do that...>>>

"This is my understanding; please correct me if I'm wrong:

Regarding income tax on an inherited traditional IRA:
- If the spouse inherits, s/he can roll it into his/her own IRA, and have no tax due at the time of rollover, but will still have to pay income tax on distributions later on, when the money is withdrawn.
- If the children inherit, they have to pay income tax when they inherit."


That is not correct.

I have previously posted a link to the Schwab guide (and am too lazy tooo look tonight). The gist of it is a 2 x 2 matrix, which depends upon wehther a spouse or a non-spouse inherits and whether the deceased had been obnligated to start RMDs. The details are all fuzzy.

You can also search "stretch IRA".

Regards, JAFO
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This is my understanding; please correct me if I'm wrong:

Regarding income tax on an inherited traditional IRA:
- If the spouse inherits, s/he can roll it into his/her own IRA, and have no tax due at the time of rollover, but will still have to pay income tax on distributions later on, when the money is withdrawn.
- If the children inherit, they have to pay income tax when they inherit.


Consider yourself corrected. No one pays income tax at the time they inherit an IRA, only when distributions are taken. Surviving spouses have some additional flexibility in choosing the timing of distributions.

Ira
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Please note that, absent a notarized waiver from the spouse, a spouse is always the beneficiary of a 401(k).
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...No one pays income tax at the time they inherit an IRA, only when distributions are taken. Surviving spouses have some additional flexibility in choosing the timing of distributions...

Thanks for the correction.

So, back to the OP's question of whether it makes a difference for income tax purposes whether spouse or children inherit IRA's, the answer is: not much.
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Another thought is that whomever you name as beneficiary will receive the 401(k), IRA, life insurance proceeds, etc outside your will so be sure you are looking at the big picture and make sure it fits into your estate plan.
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Regarding income tax on an inherited traditional IRA:
- If the spouse inherits, s/he can roll it into his/her own IRA,


They can also choose to leave it as a beneficiary IRA.

and have no tax due at the time of rollover,

Correct.

but will still have to pay income tax on distributions later on, when the money is withdrawn.

Correct. When those withdrawals must happen is the main difference between leaving it as a beneficiary IRA and rolling it into the spouse's own IRA.

- If the children inherit, they have to pay income tax when they inherit.

No. They also pay tax when the money is withdrawn. They just have fewer options about the timing of the withdrawals.

So this looks to me like a pay now vs. pay later scenario, as opposed to pay more vs. pay less.

Well, yes and no. It is definitely a pay now vs. pay later situation. And under the current laws, it's all ordinary income no matter who withdraws the money or when they withdraw it. But the taxes could be higher or lower depending on who is withdrawing the money and what their personal tax situation looks like when they make the withdrawal.

Sometimes it makes sense for elderly parents to withdraw more than the RMD from their IRAs because they will pay less tax than their children. Or maybe they will pay the same tax, but that gets the assets into investments which will get a step up in basis at their death.

Sometimes it makes sense for elderly parents to take only the RMDs because their children are the ones expected to pay the lower taxes. That might also be a reason to name the children as beneficiaries rather than a spouse, but only if they are really sure the surviving spouse will never need the money.

You've really got to look at the whole family to manage the taxes on IRAs which are going to be passed from generation to generation.

--Peter
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Please note that, absent a notarized waiver from the spouse, a spouse is always the beneficiary of a 401(k).

Thanks for that info. A new company just took over the 401(k) here at work and they had us designate beneficiaries online. It all seemed very simple, and I had no idea about the notarized waiver ...

--SirTas
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YewGuise:

<<<...No one pays income tax at the time they inherit an IRA, only when distributions are taken. Surviving spouses have some additional flexibility in choosing the timing of distributions...>>>

"Thanks for the correction.

So, back to the OP's question of whether it makes a difference for income tax purposes whether spouse or children inherit IRA's, the answer is: not much."


It is, IMO, more than "not much difference"

The Schwab Inherited IRA Beneficiary Guide is a good discussion, but I could no longer find it online. It needs to be ordered from Schwab (should be no obligation).

http://www.schwab.com/public/schwab/investment_products/reti...

The link I had previously saved no longer works. I have a .pdf copy, but cannot attach my copy.

Regards, JAFO
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It is, IMO, more than "not much difference"

I agree. The opportunity, as a spouse, to roll an account into your own IRA is a huge difference, from the options that non-spouses have.

The Schwab Inherited IRA Beneficiary Guide is a good discussion, but I could no longer find it online. It needs to be ordered from Schwab (should be no obligation).

If looking for on-line information, Fidelity has a good discussion at http://personal.fidelity.com/products/retirement/inheritedir...

AJ
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An IRA can't be put into a trust anyway, and given the spousal rollover option, the recommendation is to name the spouse as primary beneficiary and the trust as contingent.

What if the IRA beneficiary reads " pursuant to the terms of my will"?
(The will also contains credit shelter trust arrangement).
That way, the spouse can decline/waive the IRA and the IRA becomes an asset to fund the trust.
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An IRA can't be put into a trust anyway, and given the spousal rollover option, the recommendation is to name the spouse as primary beneficiary and the trust as contingent.

What if the IRA beneficiary reads " pursuant to the terms of my will"?
(The will also contains credit shelter trust arrangement).
That way, the spouse can decline/waive the IRA and the IRA becomes an asset to fund the trust.


I have no idea if such language is legal, but it isn't necessary. An IRA passes outside of probate, but not outside of the Estate. The named beneficiary can still disclaim the IRA which would return it to the Estate where it could be used to fund a trust established under the decedent's will.

Ira
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Thanks for your reply, Ira. Your comments are exactly what I understood and had as a beneficiary, but our lawyer recently suggested the change and I complied and made the change. I can easily change the beneficiary on-line after contacting him.

Joe
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.. What if the IRA beneficiary reads " pursuant to the terms of my will"?
(The will also contains credit shelter trust arrangement).
That way, the spouse can decline/waive the IRA and the IRA becomes an asset to fund the trust.?...


Be very careful about not naming individuals(like a your estate or trust) as the beneficiary.

The problem is that (as least as of a few years ago) trusts cannot own IRA's so if it isn't done exactly right the IRA might have to be liquidated to go to the trust which could generate a lot of taxes. There may be ways work around this now but even if you do it right today, the laws may be different decades from now when you die and it could backfire.

Greg
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Thanks for the feedback, Greg.
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