There are over $30 trillion in retirement account assets like IRAs and 401(k)s according to the Investment Company Institute, as defined contribution plans have largely replaced traditional pensions for most private sector U.S. workers.
Because of their shelter from taxation over a lifetime of accumulation, savers who take full advantage can build a substantial nest egg by the time they retire. But what happens when the account owner dies? The disposition of retirement assets after death depends upon the beneficiary designations the owner had made and recorded with the account custodian.
The process is simple, but failing to name beneficiaries while you are living or forgetting to update them when major life changes occur can have unexpected and sometimes highly unfortunate consequences once you pass on. And it happens all too often.
Retirement accounts fall into a category of assets that pass to heirs directly by operation of law outside of your will and are therefore not subject to the cost and delay of probate. That is, if the paperwork is in order. When enrolling in a retirement plan or establishing an IRA account, the holder should stipulate the person or persons who should receive the assets upon their death, known as the beneficiaries. If done correctly, the assets pass seamlessly to the intended heirs outside of the estate and retain some degree of their tax-advantaged status after the transfer. If not done correctly or neglected altogether, interesting things can happen. Here are some of the most common mistakes.
Failing to name a beneficiary. This is the most basic and ironically the most frequent mistake investors make when enrolling in their employer’s plan or rolling over their plan assets to an IRA. According to retirement plan administrator Ascensus, one third of all IRA death claims submitted for processing lack a named beneficiary. In such cases, instead of passing directly to heirs, the money typically flows into the decedent’s estate, where all kinds of mischief can ensue.
The retirement assets are now subject to the dictates of the will and must be probated, which is a public process and potentially expensive process. In addition, while an inherited IRA with a properly identified beneficiary can generally be distributed over 10 years, or in some cases stretched over their lifetime, the distribution rules change and the money is taxed at the estate’s marginal rate, which can be higher than for the individuals named in the will. Furthermore, the IRA or 401(k) money is now available to creditors of the estate. And until the account is fully distributed, the estate must remain open and file tax returns. And if you don’t have a will, which is also unfortunately too common, the assets are distributed according to state intestacy laws.
Failing to name contingent beneficiaries. Getting the beneficiary right is key, but what if both the holder and the beneficiary are deceased? In this event, any “contingent” or backup beneficiaries named on the account step in to receive the assets as directed. The holder may specify what percentage goes to each contingent, as many as they like. Failing to name contingent beneficiaries causes the account to pass through the estate as if no beneficiary had been selected.
Forgetting to update beneficiaries after major life events. Divorce happens. But sometimes, account holders or plan participants forget to update their beneficiary designation, leading to potentially interesting outcomes. The US Supreme Court has ruled that the beneficiary listed on any qualified plan assets under ERISA (company contribution plans) is entitled to the loot even if that person is no longer married to the decedent. This could conceivably color the tone of the inscription your new spouse choses for your epitaph.
As for IRA accounts, state law dictates what happens after divorce, and in some states the divorce decree nullifies the prior designation. In Tennessee, a divorce generally revokes the former spouse’s rights to inherit under a will but not for an IRA account. This is also true for other assets that pass to named beneficiaries like life insurance and transfer on death (TOD) accounts that operate under contract law. Filing new designations with the custodian is the only failsafe.
Naming a minor or young adult as beneficiary. Most states will not allow minors to inherit substantial assets without oversight. That means that there will likely need to be a conservator named by a court, at substantial expense, to supervise until the age of majority. At that point (18 or 21 in various states), Junior gets the cash and is free to sink the entire amount into Bitcoin or a new Corvette. If it is your wish that a minor should receive a significant amount, seek the advice of an estate attorney, who can help you evaluate options like a trust account to allow more control over the distribution after you’re gone.
As with any significant financial consideration, it is important to consult with trusted counsel to assist in getting it right. Competent financial advisors will insist that you make proper beneficiary designations and should touch base periodically regarding any significant life changes that may require revisiting the designations. For instance, the birth of additional children, or the death of a named beneficiary are sometimes overlooked.
You should also integrate your beneficiary designations with any broader estate plan considerations. For example, some complex situations or special needs situations may call for designating the estate or a trust as beneficiary, but these are relatively rare and require specialized expertise. For most of us, a simple beneficiary designation ensures that your wishes are carried out promptly and efficiently, as long as it is correct and up to date.
Source: www.timesfreepress.com
