I recently spent the afternoon with an elderly woman planning how to distribute her large real estate holdings fairly upon her death.  I asked her how she had accumulated all that property.  She said that her husband had died at fairly young age leaving her with life insurance proceeds.  She used that money to pay off her mortgage and purchase more land.  She worked the land and continued to buy more land as she had the resources to do so.  In contrast, that evening I visited with a  one of the county’s homeless as a volunteer in our church’s outreach to the homeless.  I asked her how she ended up in the shelter.  She said that her husband died and she lost her house as her income was not enough to cover her house payments.  That day made clear to me the lesson of the need for life insurance to protect your family.

Before purchasing a life insurance policy, I would recommend that you contact an attorney to see whether an Irrevocable Life Insurance Trust is right for your situation.  Although life insurance proceeds are exempt from income taxes, the amount is included in your total estate.  An Irrevocable Life Insurance Trust puts the money outside of your estate and in a trust where you specify how the money is used.  As an alternative, your revocable trust or trust setup by a will can be a beneficiary for your life insurance proceeds ensuring that the money is spent according to your wishes.  This is especially critical if you have a life insurance policy setup to take care of your children.  If you already have life insurance, a quick review of the beneficiaries is a prudent step to ensure that the government is not a beneficiary of your insurance.  If your estate is named as the beneficiary of your life insurance policy, as a minimum the cost of probate will be increased by the life insurance amount.  Putting that money in the estate will also allow creditors to make a claim on the life insurance proceeds.  Mistakes in beneficiary designations are becoming more common as life insurance policies are bought on-line or part of a company compensation plan without an insurance agent to advise the policy owner on proper designations.

I recommend using this format: John Smith IRA/ Deceased 1/1/2009/ FBO (for the benefit of) Mary Smith as beneficiary.

Make sure that the financial institutions gets the titling right not only on the statements it sends to you, but also on the internal records it uses for reports to the IRS, he says. Some large IRA custodians use the beneficiary’s name on the statements sent to him or her, but use the formal titling (as in the “John Smith” example, above) on the information it sends to the IRS to avoid confusing beneficiaries.

After you have retitled the inherited IRA, you can stretch out withdrawals from the account across your lifetime, rather than being forced to withdraw the funds sooner. That action gives you a chance to extend the time that tax-deferred earnings can accrue which should reduce the tax burden on the distributions.  Distributions for an inherited IRA generally have to be made every year. The first has to be made by Dec. 31 of the year following the year of the original owner’s death.

If you inherit an IRA along with other heirs, such as siblings, you can split up the account, allowing each heir to spread withdrawals across his or her own life expectancy. Otherwise, you get stuck using the life expectancy of the oldest heir.

One other note: Just because you have to leave the IRA intact doesn’t mean you’re stuck with the original investment or custodian. You can use a trustee-to-trustee transfer to move the account directly to another financial institution.

Beneficiary designation is critical to your estate plan especially when naming who gets the proceeds of your life insurance proceeds and your retirement plans. These funds are transferred directly to the people you name without going through probate. A spouse has the option of rolling over retirement monies into his or her IRA. Required distributions from an inherited IRA are based on the age of the oldest beneficiary. Charities can be named as beneficiaries and the payment will not be subject to income tax. Life insurance proceeds can be paid to a trust and held for the benefit of minor children. These are just a few of the considerations when designating your beneficiaries. Please consult with an attorney as the beneficiary designation must be part of a complete estate plan.