Not a Lexis Advance subscriber? Try it out for free.

Estate and Elder Law

McNees Insights on Estate Planning: Who Gets Your IRA? – 6 Common Mistakes

By David M. Watts, Jr. |

Do you want your heirs to have to chase after your 401K or IRA money? Many of us have a significant portion of our assets held in retirement plans, such as 401Ks and IRAs, and your Will does not control who gets your 401K or IRA.  Therefore, it is important to make sure you have an up-to-date beneficiary form. The beneficiary form trumps your Will, and filling out the beneficiary form correctly is critical. The biggest mistakes: 

  • The form is out of date. Any time there are significant changes in your life, such as marriage, birth of a child or grandchild, divorce, job change, retirement, or death you should review your beneficiary forms. Your will cannot change the beneficiary of your plan, and it is important that you review the beneficiary form regularly. A divorce decree does not automatically sever an ex-spouse as the beneficiary of an IRA, particularly if it is governed by ERISA (such as a rollover IRA), and it is exceedingly important for all beneficiary forms to be changed after a divorce.  Another problem we sometimes see is accidental disinheritance of a child’s family. You name your three children as beneficiaries, intending for each child to receive one-third, and your oldest child predeceases you. At the time of your death your two surviving children receive fifty percent each instead of the one-third you intended. Your oldest child’s family gets nothing. The problem could have been avoided with appropriate wording on the beneficiary form.  This is not always easy to accomplish given the space limitations on the beneficiary form, but sometimes can be done through an attachment to the form. 
  • Nobody can find the beneficiary form. If there is no form filed with the plan administrator, you are stuck with the default provisions of the plan. Sometimes it will go to your estate, but not always.  In addition it may be the case that the plan administrator cannot find the form either. With companies going through reorganizations, going out of business, getting sold, or moving, files get lost or misplaced. Therefore, you should get a copy of your beneficiary form from the plan administrator, and make sure that you keep all of your beneficiary forms – retirement plans, life insurance, annuities, etc. - in a place that you and family can easily find. All of your planning is useless if these forms cannot be found. 
  • A minor should not be directly named as a beneficiary. A minor cannot control funds, and a court appointed guardian will be in control. When the child turns 18, the child will have unrestricted access to the funds. The best solution is to up a trust as the beneficiary instead of the minor so the funds are managed under your instructions by a trustee of your choice. 
  • There is no backup beneficiary named. If you do not name a back-up beneficiary then any number of people or your estate could end up with the plan assets if the primary beneficiary predeceases you.  Each plan administrator has its own rules for this kind of situation.  For example, you name your spouse as the only beneficiary. If your spouse dies before you, and there is no beneficiary named, your 401K or IRA may be liquidated, taxed and what is left held by your estate for distribution to the beneficiaries of your estate. While this is not the end of the world, with proper planning your beneficiaries could have allowed the assets in the account to grow tax free and receive distributions over a period of time. Therefore, it is a good idea to name someone, say your adult children, or a trust for your minor children, as the back-up, secondary or contingent beneficiaries. In the case of a single person with no heirs, or for someone who is charitably motivated, a favorite charity canned be named as the backup beneficiary. Naming a charity as the primary or contingent beneficiary of your 401K or IRA is a great planning technique because the charity will pay no income tax upon receipt of the IRA funds.  It is much more tax efficient to use your IRAs to make charitable gifts at your death and let your heirs receive the non-tax deferred assets. 
  • No creditor protection for the beneficiary. Many potential IRA beneficiaries lack good money management skills, could get divorced, or experience business failure.  Assets retained in IRAs are much safer for these purposes than assets held outright.  A trust can be used to restrict the distribution of assets held in an IRA. 
  • Missing out on opportunity to stretch out the payment of your IRA funds to your beneficiaries. The stretch IRA is set up through your beneficiary form. Stretching the IRA payments over the lifetime of the beneficiary allows the IRA to grow tax deferred while making relatively modest annual distributions. But, statistics show that a very high percentage of IRAs are cashed out within 6 months of death. This problem can be avoided by putting a trust can be put in place to make sure that the funds will be used over a lifetime instead of immediately withdrawn. 

The bottom line: Done correctly your 401K or IRA can preserve some significant funds for future generations to enjoy. The rules surrounding retirement plans and IRAs are complicated, but don’t make matters worse by not paying attention to your beneficiary forms. When a good portion of your assets are held in an IRA or other form of retirement plan please consider expert help.

© 2014 McNees Wallace & Nurick LLC 

McNees Insights is presented with the understanding that the publisher does not render specific legal, accounting or other professional service to the reader. Due to the rapidly changing nature of the law, information contained in this publication may become outdated. Anyone using this material must always research original sources of authority and update this information to ensure accuracy and applicability to specific legal matters. In no event will the authors, the reviewers or the publisher be liable for any damage, whether direct, indirect or consequential, claimed to result from the use of this material.

For more information about LexisNexis products and solutions, connect with us through our corporate site.