Too often, people give little thought to the decision in designating a beneficiary for their retirement accounts, such as an IRA. The beneficiary you name can make a big difference in how the benefits will be distributed and how much your beneficiary will receive.

Traditionally, people name their spouse as the primary beneficiary and their children as contingent beneficiaries. In the alternative, the surviving spouse is named as the primary beneficiary and the person’s estate or a trust is designated as the contingent beneficiary. Each has its advantages and disadvantages.

Naming your spouse as primary beneficiary typically provides more options and benefits. For instance, if an owner of an IRA has not begun taking distributions from his or her IRA prior to death, the surviving spouse can begin taking distributions from the IRA based on his or her life expectancy without any penalty. Alternatively, the surviving spouse can postpone taking withdrawals until April 1 of the year in which the deceased spouse would have turned 70 ½ (the age at which the owner of the IRA would have been required to begin withdrawals). The surviving spouse also has the option to rollover the account assets into his or her own IRA account. If you wish to leave IRA funds in trust for the benefit of your surviving spouse, careful planning is necessary to avoid adverse income tax consequences.

Naming your children as contingent beneficiaries may or may not be the best arrangement. By doing so, the proceeds will be distributed to them outright. There are pros and cons to this arrangement. The primary advantage is that the children can take distributions from the IRA based on their life expectancy. In other words, no income tax will be due until a distribution is made. Furthermore, only the amount distributed will be subject to income tax. Generally, without any legal planning, if the beneficiary of an IRA is the IRA owner’s estate or a trust he or she established, the IRA proceeds must be distributed to the estate or the trust in an accelerated fashion, and tax deferral would be lost. A primary disadvantage in naming children as a direct beneficiary is that if a child is still a minor, a court appointed conservator will need to receive a distribution for the minor child. Additionally, by naming a child as a beneficiary, the assets bypass any sort of trust set up for a child within the decedent’s will or revocable trust. Without the proceeds going into a trust for a minor child, the child will be legally entitled to the funds when he or she is no longer recognized as a minor.

It is possible to designate a trust as the beneficiary of a retirement account, and still keep the IRA intact so that future minimum required distributions from the IRA to the trust are based on the eldest beneficiary’s life expectancy. This however, requires careful drafting to ensure the trust (whether created in a will or a revocable trust) has certain provisions required by the IRS. If your retirement plan funds are a significant portion of your wealth, it is even more important to ensure these funds are properly addressed in your estate plan.