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. It is advisable to periodically check the designation on file, to make sure it’s still 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 have had children or grandchildren be sure to make sure your beneficiary designation forms are up to date.
With an IRA, you can name any beneficiaries you want. Some examples include friends, family members, a trust or charity. Make sure to name both primary and alternate (contingent) beneficiaries. A trust must be property drafted and meet certain requirements set by the IRS in order to be accept the IRA distribution. An experienced estate planning attorney should prepare this trust. Never name a minor as a beneficiary of an IRA. Instead, name the trust for the minor’s benefit as the beneficiary.
Another thing you should never do is name your estate as the beneficiary or fail to name a beneficiary. Doing that will cut short the tax benefits available to these tax deferred accounts. If the account is a Roth IRA, all funds must be withdrawn within five years. For a traditional IRA the same rule applies unless the former owner was already 70½. In that case 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 inherited IRA assets into their own IRA and treating these assets as if they were their own.
Maximize the stretch-out. Generally, non-spouse beneficiaries take the IRA as an Inherited IRA and must withdraw a minimum amount each year, starting on Dec. 31 of the year after they inherit the account. The beneficiaries can chose to take these minimum required distributions over their own expected life spans. This is known as the stretch-out. Stretching out the IRA gives the funds extra years and potentially decades of income-tax-deferred growth.
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 the predeceased beneficiary’s surviving children, rather than automatically having that beneficiary’s share go to other surviving beneficiaries.
Once you have completed the beneficiary designation form, ask an estate-planning lawyer to review it to be sure your retirement accounts are coordinated 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.