IRA Beneficiaries The Most Overlooked Tax Planning Need

Dentists have accumulated tremendous wealth in retirement accounts through careful tax planning during their careers.

By Brian Hufford, CPA, CFP®

Dentists have accumulated tremendous wealth in retirement accounts through careful tax planning during their careers. For most, these retirement assets are by far the single largest estate asset. But what happens to these accounts after a dentist dies?

Most dentists have done very little or no planning to protect heirs from unintended tax consequences on retirement accounts. They may have performed very detailed estate and trust planning and have wills that are a work of art. But without careful planning for beneficiaries on retirement accounts, they may have missed the most important tax planning of all. Most dentists overlook the need for this planning, thinking their estate documents cover this. Typically, they do not.

While there are beneficiary horror stories, such as the dentist who died without remembering to change a divorced spouse as beneficiary, most problems related to IRA beneficiaries are due to the inability to stretch payouts over the lifetimes of a spouse, children, and grandkids. Doing this can result in an immediate or accelerated income tax for beneficiaries.

By achieving the longest “stretch” possible with good beneficiary planning, parents can assure that subsequent generations and not the IRS realize the rewards of their savings. The extent of beneficiary planning performed by most dentists is simply to name a spouse as primary beneficiary. There has been no thought or planning related to distributions beyond this most basic level of primary beneficiary. The area of beneficiary planning is an incredibly complex subject, and an amazing tax-saving opportunity at the same time.

To illustrate extremes in planning sophistication, let’s assume that your widowed mother has a large IRA account with you as an only child beneficiary. Upon her death, the IRA custodian merely sends you a check for the proceeds from the IRA. With no planning, this distribution would be taxed as a single lump sum in the year of distribution.

The ability to defer taxes for many years would be lost. This horrible outcome begs the most basic questions of IRA beneficiary planning: Who should the beneficiary of Mom’s IRA have been — her estate, you, or your children? In addition, what planning should have been conducted to avoid an immediate income tax?

These questions are at the heart of the planning needed to create tax-deferred wealth for families. Below are areas that you should be sure to address for retirement or IRA accounts:

Who are the current primary and secondary beneficiaries for your retirement and IRA accounts?

First, you should always know who your designated beneficiaries are, perhaps by keeping the most current copies of those documents with your will and trust documents. You should also be aware of when changes to beneficiaries are needed, such as in a divorce. Typically, your spouse should be your primary beneficiary, but there are times when this might not be the case. One instance might be if you have a large net worth and want to split the estate tax exemption between you and your spouse, by making your children the primary beneficiaries.

The best secondary beneficiary may not be your estate, which could greatly limit your ability to stretch the taxable payouts from retirement accounts. If you have children and grandchildren, planning for secondary beneficiaries becomes a critical element of income tax planning. Rather than making your estate the secondary beneficiary and limiting the time for payouts of IRA benefits, in most instances it is better to have children as secondary beneficiaries.

Be sure to conduct multigenerational planning

With so much of America’s wealth in retirement and IRA accounts, the need for sophisticated guidance and planning for beneficiaries has never been greater. When estate exemptions were small, most parents were primarily concerned about the estate taxes on IRA accounts.

With larger exemptions for estate taxes, income taxes are now the primary source for needed planning. This is controlled by designating the correct beneficiaries and making the proper elections. The ability to hold IRA monies in multiple IRA accounts with different beneficiaries for each adds to the potential for avoiding income taxes for multiple generations.

Once you or your parents have accumulated amounts in excess of $500,000 in retirement or IRA accounts, you should make a mental note that you need to conduct sophisticated beneficiary planning to assure that your family holds on to as much as possible of your hard-earned savings.

Brian Hufford, CPA, CFP®, is CEO of Hufford Financial Advisors, LLC, an independent, fee-only planning firm that helps dentists achieve financial peace of mind. Contact Hufford at (888) 470-3064 or bhufford@huffordfinancial.com.

More DE Articles
Past DE Issues
More in Practice