Contributing to an IRA can help you build some of the resources you will need to enjoy a comfortable retirement. But what happens to your IRA if you don’t use it up in your lifetime?
You can still put the IRA’s assets to good use — as long as you’ve made the right moves and communicated your wishes clearly to your family.
When you opened your IRA, you should have named a beneficiary — someone who will receive the IRA assets when you pass away. You could also name a contingent beneficiary if the first beneficiary dies before you. These beneficiary designations are important because they can supersede the instructions left in your will.
If you name your spouse as beneficiary of your IRA, he or she has options unavailable to other beneficiaries. Here are two possibilities:
Roll over assets into a new or an existing IRA — Your surviving spouse can roll over your IRA’s assets into his or her IRA or use the money to create a new IRA. And, as long as your spouse is eligible, he or she can then add new contributions to the IRA. This could be a good choice if your spouse won’t need the money right away and would like to keep it in a tax-advantaged account for as long as possible. Upon reaching age 70½, though, your spouse will likely need to start taking withdrawals (“required minimum distributions”), unless the inherited IRA was a Roth IRA.
Convert the assets to a Roth IRA — If you are leaving a traditional IRA to your spouse, he or she could roll over the assets into a new or an existing IRA and then convert the assets into a Roth IRA. This move gives your spouse at least two potential advantages. First, if certain requirements are met, no taxes are due on the withdrawals. Second, as mentioned above, no withdrawals are even required — your spouse can leave the money intact for as long as desired. However, taxes will be due on the amount converted to a Roth, so this conversion may only make sense if your spouse has enough assets available in a nonretirement account to pay the tax bill.
Thus far, we’ve just talked about your spouse as the beneficiary. But what might happen if you’ve named someone else — perhaps a child or grandchild — as the primary beneficiary of your IRA? In this case, the beneficiary won’t have the option of rolling over the IRA. Instead, he or she can either take the money as a lump sum or take distributions over time. If you pass away before age 70½, and you hadn’t started taking the required minimum distributions, your beneficiary must start taking withdrawals by Dec. 31 in the year following the year in which you pass away. These withdrawals can be stretched out over your beneficiary’s lifetime, though, spreading out the tax obligations. As an alternative, your beneficiary can delay taking distributions, but he or she would need to withdraw all the money within five years of your death.
When dealing with any aspect of your estate plans, including naming beneficiaries for your IRA, you’ll want to consult with your tax and legal professionals. You put a lot of time and effort into building the assets in your IRA — so you’ll also want to take care in how you pass these assets along.