Tips on the best way to pass your IRA down to your child

Q: I some questions regarding my estate plan. My wife and I each have an IRA and we are the beneficiary for each other. When we pass, our daughter is the final beneficiary on both. When she inherits the IRAs, what is best for her to avoid taxes and let them grow until a proper age? — Rich Michaels, New Jersey

A: The good news is, if you each simply name your daughter as your "contingent beneficiary" (to inherit the IRA if the other spouse does not survive you), she will have the right to hold that account as an "inherited IRA," says Natalie Choate, who practices law with Nutter McClennen & Fish and is the author of Life and Death Planning for Retirement Benefits and The QPRT Manual.

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“She will be entitled, under today's rules, to withdraw the money gradually, over her life expectancy,” says Choate. “Thus, though she must withdraw from it a certain amount each year — it’s called a required minimum distribution, or RMD — and pay tax on that amount, the required withdrawals would be small, especially in the early years.”

In fact, Choate estimates that the account should last until she reaches her mid-80s if she takes advantage of this "life expectancy" or "stretch" payout. Of note, the IRA provider or any competent financial planner should be able to guide her on the required withdrawals.

The bad news, says Choate, is this: There's nothing to prevent her from taking out more than the RMD, or even cashing out the whole account immediately after your death. "To prevent that you'd have to go a much more complicated route, either putting your money in a ‘trusteed IRA’ or leaving the IRA to a ‘see-through trust’ for your daughter's benefit,” says Choate.

And for that, you’ll need expert legal advice. But, says Choate, it does work to keep a beneficiary from unwisely cashing out an inherited IRA prematurely.

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One more bit of bad news: Congress right now is considering legislation that would force a five-year payout for inherited IRAs over $450,000. You might consider, says Choate, writing to your legislator if you are opposed to this change in the law.

Robert Powell is editor of Retirement Weekly, contributes regularly to USA TODAY, The Wall Street Journal and MarketWatch. Got questions about money? Emailrpowell@allthingsretirement.com.