If you participate in the retirement savings plan at work such as a 401(k), 403(b) or Simple IRA, you own an IRA, or you own life insurance, you have been asked to fill out a beneficiary form. But why? If you are married, you might think that everything would go to your spouse anyway, so why bother?
Well, it actually could be a rather big deal if you don’t. Here are four reasons why:
- It’s easier with the form. If there is a completed beneficiary form, the instructions on who owns the retirement asset are clear. The retirement custodian will quickly act on the instructions and efficiently transfer the account to the rightful beneficiary. Without the form, the account must go through probate and will likely create additional legal fees to complete the process. And the extra legal maneuvers take additional time. In some cases, the delay can be quite a burden on your heirs. If you have multiple beneficiaries, without clear instructions, you are just inviting disagreements. If you complete the form, your wishes are known and disputes are fewer.
- You could cost your heirs money. Often the options for distributing retirement assets after the death of the owner are dramatically reduced without a beneficiary form. If your intended beneficiary is your spouse, things are better, but if the intended beneficiary is not your spouse, your family does not have the option of protecting the retirement assets from taxes as they transfer to children or grandchildren without a beneficiary form. In this case, the account will move to your estate, and because the estate is not a person, the account will be required to distribute within five years. The account can move to children or grandchildren via the estate, but they will receive the taxable income (and a tax bill) much sooner than they would under the beneficiary form.
- You might have forgotten your ex-spouse. If they are still on the beneficiary form of an old life insurance policy or company retirement plan, they will receive the benefits, no matter how long you have been divorced. Even if you are sure your divorce decree spelled everything out, it’s still important to check as demonstrated in the landmark S. Supreme Court case Kennedy v. Plan Administrator for DuPont Savings and Investment Plan. In this case the justices ruled unanimously that a retirement account should be paid to the ex-wife because she was never removed as the beneficiary after a divorce, even though she waived her rights to the account as part of the divorce settlement. The daughter was supposed to be the beneficiary, but instead lost the $402,000 401(k) her father had intended for her to inherit. This was an eight-year court battle between the daughter and the plan administrator — all because the beneficiary form was not updated after the divorce.
- Your fabulous estate plan won’t work without the form. If you have a large, complex estate you might want a trust to be the beneficiary of your IRA. Usually this gives the owner more control over how the money is distributed after her death. You will need the beneficiary form to name the trust. And if you have updated your estate plan, you want to confirm that you didn’t accidentally eliminate the trust language in the update. All new wills revoke all previous wills so a trust included in a prior will needs to be specifically included in a revised will. It seems simple, but the IRS files are full of cases where this was missed.
And be sure a regular review includes the custodian’s beneficiary form. If your financial advisor has changed custodians, new beneficiary forms will be created. If there is an error on that form, it will derail the entire plan. I recently read an article from Ed Slott CPA, and IRA expert where he talked about just such a case. An advisor changed IRA custodians and the beneficiary forms where mistakenly changed to the estate rather than a trust. Since the estate was the beneficiary at the date of death the IRS ruled – after much time and $30,000 in expenses – that the IRA must pay out within five years. This is the IRS five-year rule that states that when the IRA owner is younger than 70 ½ years at death and the estate is the beneficiary, there is no way to calculate a required distribution schedule and therefore the IRA must be distributed within five years.
It’s worth a check
The custodian of your retirement accounts will have the beneficiary form on file. So if you can’t find your copy, you can check with them to verify who is your beneficiary today. And you can complete a new form at any time to clean up anything that does not fit.
It’s a good idea to check beneficiary forms every time there is a life event for you, or for one of your beneficiaries, like:
- Birth
- Death
- Marriage
- Divorce
- Job change
- Relocation
- Tax law changes
And while you are at it, look at the contingent beneficiaries. The contingent beneficiaries are the backups in the event that the named beneficiaries are not there to receive the account. This could be because the named beneficiaries are deceased, or they might choose to disclaim the inheritance. Whatever the reason that your primary beneficiary is not available, if you have a backup named things will go smoothly. And it gives your heirs some options in case they need them.
Consult with an advisor
It might be a good idea to consult with your tax advisor or CERTIFIED FINANCIAL PLANNER™ professional to be sure the forms are filled out in line with your intentions. A common mistake is to name the executor of your estate as the beneficiary on an IRA. Some people think that by naming the executor, that person can then see to it that the assets are split as directed in the will – not so. A beneficiary form overrules the will, so if you name one person on your IRA beneficiary form, they own it. If they gift it to a sibling, to conform with the wishes of the estate plan, the gift would be taxable income to the recipient in that year.
If you are not sure how to check your beneficiary forms, maybe you would like the help of a planner who is always an advocate for the client– a fiduciary advisor – and only works for the client – a fee-only advisor. That way you can be confident that the financial advice you get is focused on your best interests and is a good fit for your complete situation.
CFP® professionals who are fee-only and fiduciaries take a multi-faceted approach to your financial life. They can be sure that the choices you make on the beneficiary forms are consistent with your financial goals.
Yes, I am a CFP® professional. I’m always a fiduciary and I only work on a fee basis. And yes, I’m still taking on a few great families to be part of my financial planning practice.
If this article has you thinking about your beneficiary forms, contact my office at rdunn@dunncreekadvisors.com. I am always happy to meet with people who are working on their retirement plans. Dunncreek Advisors does not provide legal or tax advice, nor is this article intended to do so.
This blog is designed to provide accurate and authoritative information on the subjects covered. It is not, however, intended to provide specific legal, tax, or other professional advice. For specific professional assistance, the services of an appropriate professional should be sought.
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