Common IRA Beneficiary Designation Errors Part 1

Other than a home, IRAs and other ERISA-qualified retirement accounts are the most substantial portion of most people’s assets.  Yet they receive inadequate attention in many estate plans.  The law requires that the custodians of these accounts (the financial institution where the account is) provide for beneficiary designations and that the account custodians make an effort to see that you complete the designation.  So completing the designation must be all you need to do.  After all, we know that the government is always looking out for your best interests.  Right?

Before going on I must stress that it is important to periodically review these designations.  The elections you made twenty years ago may no longer be appropriate.  Also understand that your will or trust will NOT alter these designations.  If you named Crazy Uncle Joe as your beneficiary because you didn’t have kids back then, it doesn’t matter that your will says ‘give it to my kids’.  (Unless Crazy Uncle Joe is dead, then your account will probably go through probate.  IRA funds often wind up in probate because the beneficiary predeceased the IRA owner.)

Now for the real point of the article.  When most people select IRA beneficiaries, they select their spouse or their children.  As reasonable and simple as this seems, it can cause problems.  Consider these two scenarios.

Suppose you leave your IRA account to your spouse as IRA beneficiary.  It will (naturally) inflate your spouse’s assets.  If your spouse later dies with an estate exceeding the estate tax threshold, you/your spouse will pay estate tax.  So by leaving the IRA to your spouse, you have potentially created unnecessary estate taxes by making the survivor’s estate larger.  Also, if your spouse remarries, the new spouse may wind up owning part or all of the funds.  Planning is critical.

So to avoid these problems, you name your son as IRA beneficiary.  But now your son has total control over the asset (after your death).  He may withdraw the funds immediately and decide to buy a mansion jointly with his spouse (whom you dislike).  To complete your misery, let’s say that the following week your daughter-in-law files for divorce and winds up getting to keep the mansion in the settlement.  You just gave the despicable daughter-in-law a mansion with your IRA money.  Is that what you worked and saved to do?

Clearly, the IRA distribution plan of naming the kids or the spouse as IRA beneficiaries can present problems.

So to avoid the above two scenarios, lets say you decide to make your IRA beneficiary your “estate.”  You should almost never do this.  For one thing, the funds will now be subject to NC probate fees that are based upon the value of the probate estate.  Second, if the estate winds up holding the funds the IRS requires the account to be rapidly distributed rather than allowed to stretch over the lifetimes of beneficiaries (meaning big tax $).  Additionally, the IRA will now be a probate asset and subject to claims of creditors.

So what are you to do about IRA beneficiaries? How do you avoid some of these common IRA beneficiary designation errors?

One option is to establish a revocable living trust, make it the beneficiary of the IRA, and appoint a trustee that is trustworthy and has good common sense and tax knowledge.  Of course a stand-alone trust could be used for the IRA, but there is usually no reason for this.  Either way, within the boundaries of your wishes (as set out in the trust documents) and IRS-required minimum distributions, the trustee will determine who among the IRA beneficiaries (as named in the trust) will get the IRA and how much they get.  The trustee will determine how quickly this money gets distributed over and above the annual minimum amount of required IRA distributions.  If you so desire, you can even give very detailed instructions.  For example, you might say “no IRA distributions for purchases of homes with despicable spouses”.  Okay, maybe that wouldn’t be quite the way to put it…but you could accomplish that end.  Or if the money is to be used for education they you stipulate that up to $15,000 a year can be distributed,  or to start a business up to $25,000 can be distributed, and you can go on and on delivering very specific instructions.

But maybe you don’t think these potential problems apply in your case.  This may be wishful thinking, but maybe you are right.  Nevertheless, that doesn’t mean you are as prepared as you think.  And yes, there are circumstances when you don’t want your RLT to be beneficiary of your retirement account(s).  Planning is key.  Call us today to discuss your particular circumstances and options for handling your affairs to conserve and protect what you have worked to obtain.  It may be the best money you will spend this year.

And for more fun, look for the next article, More Common IRA Beneficiary Designation Errors, to consider even more perfectly awful pitfalls that may be lurking just around the next dark corner.

If you can’t wait and wish to avoid these and other IRA beneficiary designation errors, we can help. Give us a call (704) 784-0846 or contact us today to schedule a consultation.