11 Questions to Ask IRA Custodians

There can be time bombs and trap doors in your individual retirement accounts (IRAs). They are easy to find. Often, people don’t learn about them until it’s too late because they don’t know the questions to ask. Most people know to ask about the basic issues. They look for annual account fees, restrictions on investments, trading fees and similar issues.

But there are other important issues. Some of the issues can arise when you’re managing the IRA. But the real nitty gritty of IRAs is apparent when doing your estate planning or when beneficiaries inherit the IRA. An essential part of estate planning is to know the answers to these questions and be sure the custodian is the right one for your estate. If you have a 401(k) account, ask the same questions.

Who is the default beneficiary? When you don’t name a beneficiary or the beneficiary passes away, who is the beneficiary? The custodian decides through its default beneficiary policy. The default beneficiary might be your spouse, your estate, or someone else.

You should know. In addition, always have contingent beneficiaries who inherit after your primary beneficiary or beneficiaries. That way, the custodian doesn’t have a role in deciding who receives your IRA. Does the custodian use the per capita or per stirpes rule? This is technical but can be important when there are multiple primary beneficiaries. Suppose you have three children and name them as joint, equal primary beneficiaries.

Now, suppose one of the children passes away. You subsequently pass away before revising the beneficiary designation. If the custodian follows the per capita rule, the two surviving beneficiaries inherit equal shares of the IRA.

Under the per stirpes rule, the beneficiaries of the deceased child receive one-third of the IRA and your two surviving children each receive one-third. Most IRA custodians allow you to determine if you want the per capita or per stirpes rule by checking a box on the account application or beneficiary designation form. Can an IRA with multiple benefi- ciaries be split? The tax code allows an IRA to be split tax free into separate IRAs. You can split it during your life- time, or after they inherit co-beneficiaries can split it.

Separate IRAs for beneficiaries can be a good idea. The beneficiaries might not be able to work together on investment options, distributions and other issues. Some custodians limit your options. They won’t let an IRA owner have multiple IRAs of the same type (traditional or Roth) or will charge an account fee for the additional IRAs. A custodian might impose restrictions or fees when the beneficiaries want to split an inherited IRA.

Or the custodian might require multiple beneficiaries to split the IRA into separate IRAs for each of them whether they want to or not. You need to know the custodian’s policy on this issue and determine if that’s appropriate for your estate. Can beneficiaries direct that investments be transferred to an inherited IRA at another custodian? Your beneficiary’s financial accounts might be consolidated at a different financial services firm than yours, and the bene- ficiary may want to move the inherited IRA to that firm. There’s a procedure for this, which I’ve discussed in past issues of Retirement Watch.

The existing IRA must be retitled as an inherited IRA for the beneficiary. Then it must be transferred to an IRA with the identical title at the new custodian. The transfer also must be made directly from one custodian to the other. The beneficiary can’t take possession of the funds at any time. Some custodians will charge a fee for the transfer. Or your IRA might hold proprietary investments or other restricted assets.

The custodian won’t transfer those to another custodian. Instead, the assets must be sold and cash transferred to the new IRA. There’s no right or wrong policy. The issue is whether the custodian’s policy is good for your estate. How long can beneficiaries maintain the IRA? Usually this isn’t a problem. A custodian will allow the beneficiary to continue the IRA for as long as the tax law allows.

Current law requires most beneficiaries to distribute the IRA within 10 years. But a few custodians still require beneficiaries to distribute an inherited IRA faster than the tax law allows, usually in five years or less. This policy is more likely in a 401(k) plan than an IRA. Can the beneficiary name a successor beneficiary? Your beneficiary might pass away before the IRA is fully distributed. When that happens, who inherits the remaining balance? Some custodians allow the beneficiary to name the successor beneficiary or beneficiaries.

Others have a default policy that determines the successor beneficiary. It might be the beneficiary’s estate, spouse, or someone else. Is a custom beneficiary designation form allowed? Most people name their spouse as primary beneficiary and their children as equal contingent beneficiaries. Standard beneficiary designation forms can accommodate that. But other IRA owners have more complicated beneficiary designations. They want to leave unequal shares to different beneficiaries, name charities, or take other actions that don’t fit in the standard beneficiary form.

It is common for estate planners to prepare custom beneficiary designation forms and file them with the custodian. Often, there’s discussion between the estate planner and the staff of the custodian about the specific language. Not all custodians will accommodate custom beneficiary forms or they will charge fees to accommodate them. Can a trust be a beneficiary?

The tax law allows trusts to be IRA beneficiaries. The tax consequences to the beneficiary depend on the terms of the trust. Most IRAs must be fully distributed to the trust within five years, while others can stretch the IRA longer. But not every custodian will accept a trust as beneficiary or will require the trust document to be on file ahead of time.

Does the custodian accept powers of attorney and disclaimers? These are two separate documents with different purposes, but you might want to be sure the custodian will accept them. A qualified disclaimer is filed when a beneficiary declines to accept an inheritance. There can be good tax and nontax reasons for a beneficiary to decline inheriting an IRA, and some estate plans anticipate that the surviving family members will consider disclaimers. Initial beneficiaries might disclaim their beneficiary status in favor or other family members.

A power of attorney enables someone to take actions on your behalf when you aren’t able to do so. But, as I’ve discussed in the past, some financial services companies are selective about acknowledging powers of attorney. They might require the documents to be on their own forms, require them to have been executed within a year or less before they are used, or have other restrictions.

The point is to learn the custodian’s policies now, before the documents need to be used. What about divorces of beneficiaries? You might name your spouse as sole primary beneficiary and not be concerned about being divorced or be confident you’ll change the beneficiary designation if there’s a divorce. The custodian’s divorce policy also applies to your beneficiaries. Suppose you name an adult child as a beneficiary. The adult child becomes divorced and then passes away. Some custodians would allow the surviving ex- spouse to inherit your child’s share of the IRA if you didn’t change the beneficiary designation.

Other custodians say that an ex-spouse can’t inherit a deceased beneficiary’s share, or they use the per capita rule and don’t allow anyone related to the deceased beneficiary to inherit. Is there a cross-collateralization agreement?

You’re not allowed to borrow from an IRA or use the IRA as security for a loan. If you do, the amount of the loan is treated as a distribution from the IRA and taxed to you. You’re thinking, “That’s not a problem. I won’t borrow from the IRA.”

But when you have other accounts at the IRA custodian, be careful. Suppose you have both a brokerage account and a traditional IRA at broker. In the brokerage account, you’re allowed to buy stocks on margin, take out a margin loan against the account, and use futures and options. You take out a margin loan against the brokerage account. You think it’s not a problem.

The investments in the account are security for the loan. But the brokerage agreement might say that all the assets you have at the broker can be security for a loan taken against any account. Suddenly, your IRA is pledged for the margin loan, triggering tax consequences for you. The IRS became aware of this situation about 10 years ago and issued temporary rules that said an IRA owner wouldn’t violate the collateral rules, as long as IRA assets aren’t transferred to satisfy a loan.

But the exemption was only temporary. Many financial services companies amended their account documents to provide that IRAs can’t be collateral for a margin loan or other debt. Be sure your account documents don’t allow your IRA to be collateral for margin loans or other debts.