With estate planning, the only things that have to happen are often those that you allow to happen. Individual retirement accounts can become part of your estate – but they don't have to and probably should not. If they do, your beneficiaries lose the ability to stretch out withdrawals and this could cause a significant tax hit.
The most critical element of making sure your IRA does not become a part of your estate is selecting a beneficiary. If you name an individual, this creates a legal contract between your account administrator and that person. As such, the administrator must transfer the IRA to her when you die. Assets that pass directly to named beneficiaries do not require probate. Although your beneficiary may have to pay some taxes with this arrangement, only distributions she takes are typically taxed as income. If lump sum proceeds are paid to your estate instead, estate taxes could come due.
Naming No Beneficiary
If you fail to name a beneficiary for your IRA, or if that person predeceases you, this creates a different picture. Without a beneficiary, your IRA becomes part of your estate and it must pass through probate. The same is true if you name your estate as the beneficiary. You can avoid this by choosing a second or contingent beneficiary to inherit the IRA if your first beneficiary dies, and by making sure that your beneficiary is an individual, not your estate.
Naming a Trust as Beneficiary
Another option is to create a trust to receive your IRA in the event of your death. If you name the trust as beneficiary, the asset can avoid probate, but not just any trust will do. Special rules apply to retirement benefits. You'll need a qualified "look-through" or "see-through" trust to allow your beneficiaries to take distributions over their lifetimes rather than all at once and avoid tax complications. Several rules apply to this type of trust so if you think it might work for you, speak with an estate planning professional. For example, all your trust's beneficiaries must be individuals. You can't include a charity.
Required Minimum Distributions
If you've begun taking required minimum distributions when you die, a portion of your IRA might become part of your estate. Even if your IRA passes to a named beneficiary, if you die before you take your RMD for that year, the RMD itself is payable to your estate. The balance of your account remains safe, however. Your beneficiary would have to continue taking RMDs of her own beginning in the year after your death, but these would typically be based on her own life expectancy – they would not necessarily be the same as what yours were.