According to the IRS, more than 90 percent of all IRAs are cashed in when the second spouse dies.

If you have $300,000 in your IRA and it’s cashed in, your kids are going to report all of the income on their tax return. It’s not on your tax return; it’s not on the estate return. So if you have two kids inheriting a $300,000 IRA, you’re talking about each of them reporting a $150,000 IRA distribution on their tax return in one year. You’re leaving your kids an income tax time bomb when you leave them your retirement accounts. You want to diffuse that time bomb.

Your kids don’t have to cash in these accounts. But starting the year after your death, they do have to start taking a little bit out each year.

For instance, if a 50-year-old child has to take money out, the IRS looks at their life expectancy. If that is 33 years, then they have to take out 1/33 of the account and pay the tax on it. That’s 3 percent. They can take more if they want, but they have to take out the 3 percent. The next year they have to take out 1/32 and then 1/31 then 1/30 and so on. Every year they have to take out a little higher percentage, but they can essentially stretch those benefits of your retirement accounts across the rest of their lifetime. Or put another way, they can stretch the tax deal across their lifetimes and continue to get that triple compound interest in the retirement account that Albert Einstein called the eighth wonder of the world – the concept of triple compound interest. But more than 90 percent of the time that’s not what happens.

If the beneficiary designation has full legal control over who gets what, why would we not take the same care in writing those beneficiary designations that we do our other legal planning. I believe in a customized beneficiary designation, and I call it an IRA asset will, where you make sure you take control of the distribution options on behalf of your children and grandchildren, so they don’t have to unnecessarily cash these accounts in at death. I’m not talking about 10, 15, 20 page document. I’m talking 2, 3, 4 pages that make sure to give your kids control. And if your kids can’t handle the money, then maybe you need a special IRA kind of trust that I call an IRA trust, which still qualifies for stretch IRA that gives the control features that you need to make sure that the money doesn’t hurt the kids. So make sure that planning the ultimate transition of your retirement accounts is a central part of your estate plan.

I have published an IRA Beneficiary Checklist that refers to the need to potentially have a customized form. Check it out HERE.