Individual Retirement Accounts (IRAs) with no beneficiary designations may automatically pass to a living spouse or transfer to the IRA owner’s estate. In the former case, what happens to an IRA with no beneficiary designation is different due to the legal differences between recipients. Moreover, estates can go through a legal process called probate when no spouse or beneficiary designation exists. Probate is the mechanism by which assets and debt obligations are reviewed by a judicial body and distributed by such.
Until an owner of an IRA gives up right to the funds within an IRA, the value and assets within the IRA remain intact and belong to that owner. According to Vanguard, a large financial services firm, what happens to an IRA with no beneficiary designation may depend on the Custodial Account Agreement. That is to say, since the financial services firm is the custodian of the IRA, the terms within that agreement may specify beneficiaries in the event the owner does not. Vanguards policy on the matter is to transfer first to a spouse and then the owner’s estate if no spouse exists.
According to Mary Randolph, J.D., in a book named ‘8 ways to Avoid Probate’, contractual wills can and do take precedence over custodial account agreements despite being relatively infrequently used instruments. In other words, if no beneficiary is listed on the IRA, but the agreement automatically has a contingency beneficiary, a contractual will can override the allocation determined by the account.
In the case of a non-designated spouse, two things can happen to an IRA with no beneficiary designation. Either the funds are received in full or they can be held in an inheritance IRA for tax deferral. The advantage of the latter method is the recipient of the IRA funds has more time to determine a more tax beneficial annuity or method of withdrawal. If an estate becomes the first non-designated beneficiary probate may become a requirement that can prolong the transfer and distribution process in addition to adding legal costs.
A reason individuals assign beneficiary designation to their IRA’s is to avoid unforeseen financial circumstances and prevent third parties from determining what will happen to the IRA. Moreover, by assigning IRA beneficiary designations to an IRA, the option for less inheritance tax to paid by the IRAs funds exist in addition to the funds being allocated as wished. Designating beneficiaries is to prevent confusion and other adverse circumstances following the passing of the primary owner.
If no last will and testament exists in addition to having no designated IRA beneficiaries, the court may decide to allocate the IRA to the state. This is more likely to occur in the event no surviving relatives exist or when no clear right to claim the property exists. According to the U.S. Internal Revenue Service (IRS) another stipulation may apply to inherited IRAs. Specifically, the IRS states that individuals may only have five years to withdraw the entirety of the IRAs worth.
Sources:
1. http://bit.ly/brDZoU (Internal Revenue Service: Publication 590)
2. http://bit.ly/96FjfO (Estate Planning Law Firms)
3. http://bit.ly/c9KnLp (Mary Randolph, J.D.)
4. http://bit.ly/aXj2vw (Vanguard)