A Matter of Life and Death

October 2, 2018



The IRA Beneficiary Form


Most of you have some type of Individual Retirement Account (IRA). When you set up the account, there was a single page called something like “Death Beneficiary Information” where you wrote in a name and their percentage share. You likely designated a spouse and finished completing the rest of the account application. If you have kids, you may have designated them as contingent beneficiaries. The information you wrote down on that single sheet of paper will decide where most of your retirement savings goes when you die. 


We have been having meaningful conversations with clients about their primary beneficiaries and contingent beneficiaries of late and have jotted down a few ideas for your consideration. We think this designation should be given a look every few years to account for changes in relationships, family dynamics, and legacy considerations. 


The simplicity of the section on an IRA account application can be misleading. It doesn’t ask for much, yet it can control how millions of dollars are distributed. Here we will cover the most common designations and most meaningful trade-offs.

  • Often, clients designate a spouse or significant other as their primary beneficiary and no contingent beneficiary.

  • The second most common scenario is the spouse or significant other as the primary and a trust as a contingent beneficiary.

  • The third common scenario is when a trust is the primary beneficiary of an IRA.

What is the correct way? It depends, and that is why at the very least, we should review your IRA beneficiaries, and at the very most, review your financial goals and legacy plans to help you pass on your hard-earned retirement savings in the most efficient manner for you and your beneficiaries. {insert link to set a call w/ Bill & Julie}


Trusts and IRAs
We frequently hear clients inform us that they have a living trust to direct how their money gets distributed upon death. This is a natural assumption. After all, you paid an estate attorney thousands of dollars to create a 50-page document containing hard-to-understand legal jargon distributing your hard-earned assets. Surprise! The IRA beneficiary form overrides anything specified in your trust. You heard that right. Upon your death, the custodian holding your IRA (e.g. Schwab or TD Ameritrade) should transfer the IRA to the above referenced beneficiary or contingent beneficiary, regardless of what your trust or will says.


Common questions and answers:


Q1: What if I don’t fill out the IRA beneficiary form?
A1: Your estate inherits the IRA. Think of your estate as a “thing” or an entity. The IRA becomes available to pay your final bills, including creditors. Those distributions are all taxable to your estate, and if those taxes come out of your IRA, those tax payments are taxed. When it eventually gets into the hands of an heir, either through probate or a trust, that person must withdraw the full amount within 5 years and pay ordinary income taxes. If you were already taking Required Minimum Distributions (RMDs), your heir can continue distributions on your RMD schedule, not theirs. 


Q2: What if my designated beneficiary is no longer living when I die?
A2: See Q1 answer. Make sure you designate contingent beneficiaries to ensure there will be a living beneficiary when you die.


Q3: What if I list my trust as a beneficiary?
A3: See Q1 answer. This is a simple question with a very complex answer. In most cases, the IRA funds are required to be distributed within five years to the beneficiaries. If you leave your trust as a beneficiary and you allocate funds to people and things (i.e. charities), the account must be distributed within 5 years. If you leave your trust exclusively to people, you should consult with your estate attorney to ensure your trust is considered a qualified trust. Beneficiaries of qualified trusts cannot establish their own inherited IRA. The trustee of the trust is responsible for making distributions to the beneficiaries. If a spouse is the sole beneficiary of the trust, it would have been better to name him or her outright as the beneficiary. Additionally, distributions from a qualified trust that has established an inherited IRA are based on the life expectancy of the oldest beneficiary. If your trust beneficiaries are people, we recommend naming the people directly as IRA beneficiaries.


Q4: What if I want to leave the IRA to charity?
A4: A charity, which is tax-exempt, can draw the funds without paying income tax, so the 5-year mandatory distribution rule doesn’t apply. Also, if the estate is subject to taxes, it can take a charitable deduction for the amount left to charity. Another option is to name individuals as the primary beneficiaries and the charity as the contingent, giving heirs the option of disclaiming all or part of an IRA inheritance to charity.


Q5: What if my spouse is named as primary beneficiary but dies before I do?
A5: Best practice is to redo your IRA beneficiary form to designate primary and contingent beneficiaries. If you forget to redo the form or are unable, the IRA custodian should distribute the IRA to the contingent beneficiaries you originally listed. If you had no contingent beneficiaries listed, the IRA goes to your estate. See Q1 answer.


Q5b: What if a contingent beneficiary dies before I do?
A5b: If the primary beneficiary also dies before you (see Q5), then the deceased contingent beneficiary’s share would be equally shared among any living contingent beneficiaries, unless “per stirpes” is checked on the form. In that case, the deceased contingent beneficiary’s share would go to his/her heirs.


Q6: What if I would rather have my son-in-law or daughter-in-law inherit my IRA before my grandchild?
A6: This might occur if your grandchildren are very young. You may want their parent to inherit the IRA to have the money to care for the family. In that case, a signed letter of instruction can be added to the beneficiary form specifying your wishes. 


Q7: What happens if my kids don’t want the money?
A7: They can disclaim all or part of their share by executing a written statement to the custodian within 9 months of the date of death, providing they have not received the benefit yet. The disclaimed amount would be distributed to either their heirs (i.e. per stirpes) or to the remaining beneficiaries.


While spending thousands of dollars to create a living trust is still a worthwhile endeavor for most people, filling out an IRA beneficiary form is free, simple, and carries more weight than your trust. Take the time to think it through. Discuss it with your financial advisor. Keep a copy of the form, and let your designated beneficiaries know where it is.







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