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Question: I have recently rolled over my employer sponsored 401(k) plan into an existing IRA. I am not sure if I need to update the beneficiary designation forms on file; can you give me some advice?
Answer: Some of the most costly estate planning mistakes I see involve retirement accounts. The mistakes are usually made in the beneficiary designation forms. These forms are typically completed when the account is opened, but it can be amended at any time. The start of the New Year is a good time to make sure all your beneficiary forms are in order. This is especially true if you opened the account years ago. Check the designation on file, to make sure it’s what you intend. If you have had a major change in your family situation, for example, if you or a family member got married or divorced, a loved one has passed away, or if you have had children or grandchildren, be sure your beneficiary designation forms are up to date. You may also want to rethink a beneficiary designation because of the SECURE Act.
Naming a Beneficiary for Your Roth or Traditional IRA
With an IRA, anyone you choose can be named as a beneficiary, including friends, family members, a trust or charity. Make sure to name both primary and alternate (contingent) beneficiaries. Never name a minor as a beneficiary of an IRA. Instead, name a trust for the minor’s benefit as the beneficiary. This trust for a minor can be created in a Will or as a separate document. If leaving an IRA to beneficiaries in a trust, it must be properly drafted as a “see through” trust, meeting certain requirements set by the IRS in order to accept the IRA distribution.
A common mistake that should be avoided is naming your estate as the beneficiary or failing altogether to name a beneficiary. Doing either of these things will cut short the tax benefits available to these otherwise tax deferred accounts. For example, if the account is a Roth IRA and it names the estate as beneficiary or no beneficiary at all, all funds must be withdrawn within five years of death, instead of being distributed within a 10 year period or according to the life expectancy for certain eligible designated beneficiaries. The same holds trust for a traditional IRA where the deceased owner is under 72 – the age at which a traditional IRA owner must begin taking required minimum distributions each year. However, if the deceased owner was 72 or older, the distribution rate is based on the age of the person who died.
The best way to complete the beneficiary designation form will depend on your estate planning goals. Below are some options:
Provide for your spouse. Most married couples would typically name the spouse as the primary beneficiary of an IRA. This is because a surviving spouse has an option that nobody else has: rolling over IRA assets into their own IRA and treating these assets as if they were their own.
Consider if there is a lifetime stretch. Generally, non-spouse beneficiaries take the IRA as an Inherited IRA and must withdraw the entire IRA balance on the 10th anniversary of the IRA holder’s death. Before the SECURE Act, beneficiaries could take minimum required distributions over their own expected life spans, known as the lifetime stretch. This was beneficial because the income tax on the distributions could be spaced out over a lifetime. Now this lifetime stretch is only available to a spouse, minor child of the decedent, beneficiary no more than 10 years younger than the decedent, and a disabled or chronically ill individual.
Keep things even among the beneficiaries. If you want your three children to have equal shares of your IRA, you would list each of them on the beneficiary form and indicate that they should get one third of the account. If one of your children predeceases you, many beneficiary forms let you provide for per stirpes distributions, that is the term for passing inheritances to your deceased beneficiary’s surviving children, rather than automatically having that beneficiary’s share go to other surviving beneficiaries.
Estate Planning Advice Regarding Retirement Accounts
Once you have completed the beneficiary designation form, ask an estate planning lawyer to review it and coordinate your retirement accounts with the rest of your estate plan. The larger your retirement account and the more complicated the estate plan, the harder it may be to cover all the bases with the custodian’s standard beneficiary form.
