This is a topic that I cover with all clients, and one that I recommend you for everyone with retirement plans and other accounts with beneficiary designations. Too often we think we have the beneficiary designation form filled out just the way we want it, and then (once it’s too late) it is discovered that the form hadn’t been updated recently – and the designation is not what we hoped for.
I made this recommendation to a client not long ago. He assured me that he had all of his designations set up just the way he wanted. His wife, sitting next to him in our meeting, asked him to make sure – talk to the IRA custodian and get a copy of the designation as it stands today. A bit miffed about it all, he agreed to do so, and did the next day. Guess what he found – as it stood on that day, his IRA beneficiary designation form indicated 100% of his IRA would pass to his ex-wife from 15 years ago! Plus, he had no secondary beneficiaries named, which meant that if the ex predeceased him, HER heirs would be the primaries. Thankfully he had checked on this to avoid this awkward and possibly devastating situation.
Know what was fixed pretty much immediately?
Take the time
You owe it to yourself and your heirs to take the time to review your beneficiary designations and keep copies of them in your “dead file”. This includes IRAs, Roth IRAs, 401(k)/403(b)/457 plans, and other pensions or retirement plans. You also may have POD or TOD (Pay on Death or Transfer on Death) designations on non-retirement accounts – confirm these and keep copies as well.
For your standard retirement accounts, such as IRAs, 401(k)s and the like, you typically have the option of naming a primary beneficiary (or beneficiaries) and a secondary or contingent beneficiary or beneficiaries. It makes a huge difference on these accounts that you name a specific person (or persons) as the primary beneficiary, and a specific person (or persons) as the contingent beneficiary. With IRAs, if you leave the designation blank, you may be taking away important options for your heirs.
If you leave the primary beneficiary designation blank you are leaving the transfer of your IRA up to the custodian’s default designation. Quick! What’s your IRA custodian’s default beneficiary designation?? I didn’t think you’d know.
Often this default is your spouse first, and then your “issue” – meaning your children and other descendants. Other times, the default beneficiary is your estate. In the event that the estate is the default beneficiary, any beneficiaries of the estate will receive the IRA, but they will not be able to utilize the “stretch” option of receiving payout of the account over their remaining lifetimes. This is because the IRS rules state that a “named beneficiary” must be in place in order to use the stretch provision. If no “named beneficiary” exists, the stretch option is not allowed. If the default is your spouse and your issue, these can be treated as “named beneficiary” if they are alive.
Discuss with your heirs
At face value, even though you think your intent for your beneficiary designations is clear, it might not be clear to your heirs. For example, you may have chosen to pass along half of your IRA to your youngest child and only a quarter to the older two children because you believe the youngest child can use the money more than the other two. Or maybe you decided to leave the entire IRA to your oldest daughter, and you want to designate your three sons to split up the farmland – which you believe is an equitable division.
Whatever you’ve decided, especially if there are perceived inequities in your division plan, you should take the time to review your plan with your heirs. If that makes you uncomfortable, there are a couple of things to consider: First, if you’re uncomfortable discussing it with them, imagine how uncomfortable your heirs may be when the time comes to distribute your estate. Maybe it’s not such a good idea after all if it could cause contention among your heirs. Second, if you still believe your split is the right way to go, you should explain your plan to someone – your designated executor would be a good choice. And the designated executor should be a disinterested separate party, someone who isn’t receiving benefit from your estate plan, in order to keep the process “clean”. Otherwise, if one of the heirs is your executor and the executor is perceived to receive preferential treatment, again you’ll have some contention among your heirs.
If there are complex instructions involved, consider making an addendum to your will. Instructions in your will would have no impact on the beneficiary designations on your IRAs and other plans (these pass outside of your estate as long as you’ve made specific designations) but other asset divisions aside from retirement accounts may require explanation for your heirs to understand your intent. Don’t expect that everyone will understand or agree with your thought process when you’re gone. Explaining your thought process in advance will likely help to ensure that your division plan doesn’t result in a family rift.
Take the time to review your beneficiary designations. Make sure that you have the primary beneficiary or beneficiaries that you want, and the percentages that you’d like each to have. Also make sure that you have named contingent beneficiary or beneficiaries in the event that your primaries have predeceased you. Lastly, make sure that you note how division is done after the death of the beneficiaries: per stirpes or per capita.