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IRA could be a grand gift to a grandchild

Of the two ways to bequeath an IRA

Of the two ways to bequeath an IRA to a grandchild, the simplest is to name your grandchild the beneficiary. Credit: iStock

As you pore over your year-end income and investment statements, perhaps you are finally confident you have more than enough assets for a comfortable retirement. In that case, maybe this is the time to think about giving your grandkids something longer lasting than a yearly birthday gift. An IRA you believe you will never need in your lifetime could be the gift of a lifetime for a grandchild.

"It's a fantastic way to set a young child up for the future, for their whole life, really," says Rachel Sheedy, an editor with Kiplinger's who covers retirement issues. Sheedy examined strategies for passing an IRA to a grandchild in an article for Kiplinger's 2014 Retirement Report (bit.ly/inherited-ira).

If you want to bequeath an IRA to a grandchild, there are two ways to go. The simplest is to name your grandchild the beneficiary. (If your grandchild is younger than 18, you must also name a custodian.) After you die, the money becomes available when your grandchild turns 18. Going this route is as easy as filling out a form, and your broker or bank should do it for free. The potential problem: You might want the money to be used for college, but your grandchild could use it for any purpose.

The second method is to set up a trust. This way, you decide how, where and when the money will be spent. Sheedy calls this "a little playbook" that ensures your wishes are met, even though you are gone. To set up a trust, you will need an estate-planning lawyer, which typically costs several thousand dollars.

There are separate rules for inherited IRAs, depending on whether the beneficiary is your spouse or someone else. Assuming the beneficiary doesn't take a lump-sum distribution of the entire account and wants the money to continue to grow tax-free, a spouse can transfer the assets into his or her own retirement account. But a nonspouse who doesn't take a lump-sum distribution must open an inherited IRA. That account is subject to an annual required minimum distribution, no matter how old the beneficiary is. If your account was a traditional IRA, distributions will be taxable. If your account was a Roth IRA, distributions are tax-free, assuming the account had been opened for at least five years.

Charles Schwab has a good primer on inherited IRAs at bit.ly/inherited-schwab. Although it's written from the beneficiary's point of view, it will help anyone thinking of bequeathing an IRA.

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