Have you checked who is designated as your beneficiaries on your retirement accounts lately? For many people, naming beneficiaries happens one time, when they set up the account or policy. However, life changes (birth, marriage, divorce, death) are inevitable, and when these changes occur, you, or your family, may find that the designated beneficiary on your retirement account is not who you think it should be.
When it comes to planning for wealth transfers, it’s extremely important to review your beneficiaries periodically…especially if you have had children, divorced, or remarried since you first established your retirement account.
This also applies if you had previously named a charity or trust as your beneficiary upon account setup and that organization no longer exists.
Choosing an IRA Beneficiary
It's important to select the appropriate beneficiary for each retirement plan. Doing so may extend your retirement savings after your death and allow your money to continue to grow tax deferred. Another reason it's important to name the correct beneficiaries is to avoid probate; a long and typically expensive process that involves reviewing and determining where your will and assets will be distributed after your death. Ensuring you have selected your preferred beneficiaries is crucial, as the designated beneficiaries override any distribution requests made in a will.
There is no limit to the number of beneficiaries listed on a retirement account. There are, however, different distribution options available based on who you designate as beneficiary, whether a spouse or non-spouse is selected.
Your spouse is the only individual who can inherit your IRA and treat it like their own; they can roll it into their own IRA or leave it as an Inherited IRA and take distributions as needed. If you name a child or grandchild as your beneficiary, the required minimum distributions (RMD) (see our blog titled Everything You Need To Know About RMDs) are calculated over their life expectancies and stretches the amount of time the money can grow tax deferred.
Keeping Your Beneficiaries Current
Many people tend to neglect retirement accounts, particularly the account beneficiary designations, even if they are diligent in frequently updating other important documents, such as wills. Retirement accounts, including 401(k) plans and profit sharing plans, SIMPLE and SEP IRAs, Traditional IRAs, and Roth IRAs are not considered part of your estate. Those retirement accounts are generally not governed through your will, making it even more important that these documents be updated as well.
When considering beneficiaries for your IRA account, it is important to remember that you can select both primary and contingent beneficiaries. Contingent beneficiaries inherit the IRA if the primary precedes you in death. It is also possible to delineate beneficiaries as per stirpes or per capita – both are Latin terms used frequently in estate planning. In the event your primary beneficiary dies before you, a per stirpes designation provides that the share he or she would have received goes to his or her heirs and not your other named beneficiaries. Per Capita indicates that only members of a named group (such as ‘my children) can inherit the retirement account.
If no named beneficiaries (primary or contingent) are living, your retirement account assets may transfer to your estate, in which case state law would intervene to determine who receives the proceeds. Some may assume that the heir(s) named in the will receive all of the deceased’s assets, but beneficiary designations of retirement accounts supersede the will.
Examples
Let us look at some real-life situations.
- Example 1
- John names his wife, Sue, as the primary beneficiary of his Roth IRA and their children Ted and Mary as contingent beneficiaries of the account. Sue dies before John. When John dies, Ted and Mary will inherit the account and split it evenly. If only Ted was listed as the contingent beneficiary, Mary would not inherit anything from the Roth IRA. This is true even if she was listed as a beneficiary on John’s will.
- Example 2
- LeRoy names his children, Ann and Sandy, as the primary beneficiaries of his SEP IRA with Ann getting 60% and Sandy 40%. He lists Ann’s children Tom and Joe along with Sandy’s daughter, Marie, as equal contingent beneficiaries. Ann passes away before LeRoy. When LeRoy dies, Sandy will receive 100% of the SEP IRA. To ensure that Ann’s children receive the share intended for Ann, LeRoy would need to name Ann 60% per stirpes and Sandy 40% per stirpes. Then Tom and Joe would each inherit 30% and Sandy would receive 40%.
- Example 3
- Liz names her husband, Rich, as the beneficiary of her Traditional IRA. Liz and Rich have two children, but they are not named as contingent beneficiaries. Rich predeceases Liz. When Liz dies, her Traditional IRA will be included as part of the estate as there are no living named beneficiaries. Liz’s children will not receive any proceeds from the IRA until the estate settles probate, which could take many months or even years. Had Liz named her children as contingent beneficiaries, the distribution of the IRA could be complete within a couple of months.
Please note:
For the purpose of this blog, we are only addressing retirement account beneficiaries. Non-retirement accounts often use designations, such as joint ownership with rights of survivor ship, transfer upon death and tenants in common, but those are not included in our discussion here.
Mainstar Trust also encourages you to check with your retirement account custodian to confirm it can track per stirpes or per capita designations. Dealing with incomplete or outdated beneficiaries can be frustrating and confusing for survivors who feel your true wishes may not be reflected in the retirement account documents. Your neglect may cost the survivors time and money to work through the legal process.
In cases where state or federal courts are involved, the court’s decision may not always be what you would have wanted. This is of particular concern in divorce situations or if children were born after the initial designation was created.
What Now?
To avoid any heartache, it is best to update any beneficiary designations immediately after a change of life orfamily status, and to continue to review it periodically so the beneficiaries do not become outdated or incorrect.
Create “what-if” scenarios for beneficiary designations to help you review each possible outcome. You may also want to seek legal or financial advice to help you consider all the factors that could affect your decision.
As a beneficiary, it is important to be aware of the deadline for establishing and taking mandatory distributions from an Inherited IRA. Failure to open separate inherited accounts by December 31 of the year following the year of the original accountholder’s death could affect the rate used to calculate required distributions. For example, using the oldest beneficiary’s birthdate to calculate the required distributions for all beneficiaries, instead of basing the distribution calculations on the birthdays of the individual beneficiaries, could result in larger mandatory payments and expedite the depletion of the inherited account. Mainstar Trust will review the deadlines in more detail in a future post.
Though no one likes to think about death, you can save your loved ones time and confusion by reviewing your beneficiaries regularly. Keeping your beneficiary designations up to date is an effective estate planning tool to build and maintain wealth. Designating beneficiaries when you set up your account is the easy part. Remembering to keep the documentation updated is the important part.
If you have any questions regarding any of the many benefits and services Mainstar Trust offers as one of the country’s leading IRA Custodians don’t hesitate to contact us with all of your IRA questions.