How to Leave an IRA to Your Heirs

By Blair Hodgson DuQuesnay

NEW YORK ( AdviceIQ) -- Individual retirement accounts and qualified plans such as 401(k)s can be wonderful assets to leave to your heirs. But you need to do some extra planning to make sure the money goes to the right family members and minimize their tax bill.

Some folks are confused because IRAs and retirement plan assets pass to your heirs based on beneficiary forms and not by the instructions in your will. It's also hard to tell how long your beneficiaries may keep the money in the tax-deferred account.

If you plan to leave the assets to minor children, create a trust for them and name the trust as the beneficiary of the retirement account. Minor children are unable to legally accept an inheritance until they reach the age of majority, which is either 18 or 21 depending on your state.

In many cases, the court appoints a guardian for the minor and may even restrict the types of investments allowed in the inherited IRA. By creating the trust for the benefit of the child, you determine who has control and how the money eventually gets distributed to the child. Remember to list the trust, not the child, on the beneficiary form.

The required minimum distributions -- withdrawals from your retirement account you ordinarily must take at age 70.5 -- can be a problem with an inherited IRA, where you must begin pulling out money long before 70.5.

For multiple heirs in different generations, it's better to create separate trusts. If you use just one trust with multiple beneficiaries, RMDs are based on the oldest beneficiary's birthdate. Assume you name a trust for the benefit of your spouse, your son and your daughter for an IRA valued at $1 million; here are the annual required minimum distributions for each beneficiary based on their life expectancy:
  • Spouse (59): 26.1 years; $38,314 per year
  • Son (17): 66 years; $15,152 per year
  • Daughter (15): 67.9 years; $14,728 per year

But in this example, all three beneficiaries are required to share the maximum distribution of $38,314 per year. This is less desirable because it depletes the inherited IRA faster and results in higher taxes.