Pitfalls of IRA Beneficiaries


Don’t Derail Your Estate Planning

Declaring your IRA beneficiaries in many ways is as important as writing a will. Perhaps more so, because for many of us our IRAs are the biggest asset that we pass on to our heirs. In other words, naming a beneficiary is like having a will for your IRA.

Let’s back up a little: a beneficiary is defined by Investopedia  as following: “In the financial world, a beneficiary typically refers to someone who is eligible to receive distributions from a trust, will or life insurance policy.”

You probably remember selecting your beneficiaries when you first opened your IRA or your employer sponsored 401k. It’s wise to periodically review your beneficiaries – people you named 15 years ago may no longer be your intended recipients, if there has been a divorce or other family change.

Also be sure to name a secondary or contingent beneficiary in the event your primary beneficiary predeceases you. All beneficiaries should have a copy of the designation form in a safe place– they will need it, or will need to be able to contact your financial institution to obtain a copy.

One of the worst things you can do is name your estate as your beneficiary. Ideally your IRA should not pass through your estate. However, if your beneficiaries are not properly named, or your beneficiary form cannot be located, then it will pass through your estate. In that case, it will be distributed per the instructions in your will, but will become subject to probate.

What’s the problem with probate? Well, your IRA will then be subject to creditors and taxes which will reduce the amount you intended to leave to your beneficiaries.  There could be other legal complications as well.

Additionally, if your estate is named as beneficiary, you can no longer use any distribution strategy that is based on life expectancy, because an estate is not a person in the eyes of the law. Most likely the IRA will be paid out in lump to your estate, eliminating any chance of a tax deferred growth strategy.

Here is a fictional example to help illustrate the point:

Jim has a $500,000 IRA which is the bulk of his estate. He named his surviving spouse Mabel as primary beneficiary and did not name a contingent. Jim passes away and his IRA assets are transferred to Mabel’s IRA because she is the surviving spouse.  Mabel names her estate as the beneficiary instead of her four children. Five years later, Mabel passes away and because she named her estate as the beneficiary her IRA will now have to pass through her estate. So instead of the remaining assets going straight to the children, they will now go through probate court, which will be subjected to creditors and tax. The assets will be held up for 9 months of probate, and the children will lose any choice of distribution.

What seemed like such a simple thing when you filled out your beneficiary form can have several hidden dangers. Talk to your advisor about your beneficiaries, and talk to your parents about theirs. It may be painful to talk to your aging parents about their estate plan, but a little planning now can save you a lot of grief later.

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About Catherine Allen

With over 28 years of experience in the financial industry, Catherine is deeply compassionate and is driven to educate and empower people to make informed decisions in their financial lives. She is a CERTIFIED FINANCIAL PLANNERTM Practitioner trained to develop and implement comprehensive financial plans for individuals, businesses, and organizations. Catherine believes a financial plan is not just a snapshot but instead a moving picture that needs constant reviewing and tweaking to keep it on track. You can reach Catherine at [email protected], or by calling 856-810-7701. Securities offered through LPL Financial. Member FINRA/SIPC. LPL Financial

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