How Having Multiple IRAs Can Help Bequest Planning

Having just one IRA instead of several may simplify paperwork and minimize fees. But when you begin to think about leaving IRA funds to heirs, consider using more than one IRA to do so. Here are reasons why:

Preserve Funds for Bequests in a Roth IRA

Statistics show that the great majority of IRA funds reside in traditional IRAs. However, traditional IRAs must make annual required minimum distributions (RMDs) to their owners starting at age 70½. This works contrary to the intent of leaving IRA funds to heirs because RMDs deplete the IRA while the owner is alive. Roth IRAs, to the contrary, have no RMDs for their owners. So if you currently have all your IRA funds in a traditional IRA but would like to leave some portion of them to heirs, consider converting that portion of the funds to Roth IRA status. 

Protect Distribution Options for your Spouse and Beneficiaries.

An individual who inherits an IRA from a spouse has a unique choice: either accept the inherited IRA or convert it to an owned IRA. Keeping an inherited IRA lets a spouse beneficiary under age 59½ withdraw funds from the IRA without an early withdrawal penalty. Converting the IRA into an owned IRA lets a surviving spouse defer RMDs until age 70½ (or eliminate them entirely if it is a Roth IRA) and also name new IRA beneficiaries. Even better, the spouse beneficiary can convert the IRA to an owned IRA at any time — for instance, after waiting to reach age 59½.

But this choice is available only if the spouse is the sole beneficiary of the IRA. That being said, consider naming your spouse as sole beneficiary of one IRA while funding intended transfers to other beneficiaries through one or more other IRAs.

A non-spouse who inherits an IRA as the sole designated beneficiary named on the IRA’s beneficiary form can take RMDs from it under a schedule that “stretches” over the rest of his or her life expectancy. This can provide decades worth of compounding tax-favored investment returns in the IRA. 

But if the IRA has multiple beneficiaries, then RMDs for all must be paid on the “stretch” schedule of the oldest, who has the shortest life expectancy. This can be very costly to the younger beneficiaries. 

If a charity is one of the beneficiaries, the situation is even worse. It is deemed to have a life expectancy of zero, so no beneficiary can take a stretch. The IRA will have to be paid out in only five years if the IRA owner died before his beginning date for RMDs. If he died later, it must be paid out over the owner’s life expectancy in the year of death (not more than 17 years).

Note: These problems can be fixed after an IRA owner dies, by dividing a single inherited IRA with multiple beneficiaries into separate IRAs with one beneficiary each by the end of the following year.

But this creates risk of making costly mistakes while trying to meet deadlines and satisfy technical rules. It’s simplest and safest to set up separate IRAs in advance. 

Matching Investments to Heirs

When separate IRAs are set up for each heir, they can be funded with different assets selected for each — for example, safe bonds for a spouse, growth stocks for a grandchild. Account balances can also be adjusted for each heir in light of changing circumstances. Amounts can be transferred among them to reach desired balances, and as the RMD for a year can be taken from any traditional IRA, it can be proportioned among IRAs to reach the desired result.

Disclaimer Planning

Disclaimers can be valuable tools in estate planning. For instance, an adult in a high tax bracket who is a beneficiary of an IRA but doesn’t need it, may disclaim so that it passes to the “next in line.”  If each IRA has a single beneficiary, then each can have a chosen contingent beneficiary to be “next in line,” such as the beneficiary’s child, making disclaimer planning straightforward. But if one IRA has multiple beneficiaries, disclaimers may be much more difficult to use.