How to Avoid Frequent IRA Mistakes

Mistakes and over-sights by IRA owners prevent their heirs from maximizing the after-tax benefits of the accounts. The source of many problems is the IRA beneficiary form, a document to which most IRA owners devote only a minute or so. This form should be an important element of an estate plan, and some IRA owners should skip the standard forms offered by the IRA custodian and submit their own customized beneficiary forms.

The tax law and IRS regulations issued in the early 2000s provide opportunities for IRA beneficiaries to extend tax deferral. The opportunities can be seized only if the custodian allows and if the beneficiary form is drafted properly.

The tax law allows multiple beneficiaries to split an IRA into separate IRAs, giving each beneficiary his or her own IRA. Yet, the custodian does not have to allow this. Check with a custodian to ensure it will allow an inherited IRA to be split, and ask about any costs of doing this.

Some custodians assume that multiple beneficiaries own equal shares of an IRA. Your intention might be otherwise, leaving the beneficiaries uneven shares of the same IRA. If so, you either have to add some detail to the standard form or submit your own customized form.

Also under the tax law, the final designated beneficiary does not have to be determined until the September of the year following the owner’s death. The estate executor, perhaps guided by any directions left by the owner, can choose who should be the beneficiary. Tax situations, the disposition of other assets, and the financial conditions of all the beneficiaries can be assessed.

A related tool is the disclaimer power. Suppose your spouse is named sole beneficiary of the IRA but also inherits enough other assets to provide a comfortable standard of living. To avoid having the extra income from the IRA, he or she could disclaim the inheritance of the IRA and let another family member inherit it.

For these last two tools to be available, however, the beneficiary form must designate a number of beneficiaries and contingent beneficiaries. The executor can select the designated beneficiary only from primary and contingent beneficiaries named on the designation form. Other loved ones are not eligible. Similarly, a disclaimed IRA can be inherited only by someone who was next in line as a named primary or contingent beneficiary.

Another issue with multiple beneficiaries is what happens when a beneficiary passes away before inheriting the IRA.

Suppose you have three adult children and name them as equal primary beneficiaries. One of them dies before you and also before you update the beneficiary form. Do you want that child’s children to inherit that share of the IRA, or do you want the other adult children to split that share? Most IRA custodians have a default treatment of this issue. Some will give account owners a choice. You need to consider your preference, and determine how your custodian handles it. You might need to update the beneficiary form, provide a customized form, or switch IRA custodians.

The tax law also allows an IRA beneficiary to name his or her own beneficiary of the IRA or share of the IRA. Some custodians do not allow this, or you might need to submit a customized form to allow it.

Some custodians will communicate only with the owner and beneficiaries of the IRA, not the estate’s executor. This can make it difficult for the executor to do his job. A customized beneficiary form can authorize and direct the custodian to communicate with the executor.

If you are considering naming a trust as the IRA beneficiary, does the custodian allow this? The tax law allows it, but the rules are complicated. Some custodians don’t want to bother with the details. Does the custodian accept a power of attorney for someone to act on behalf of either you or the beneficiary? Most custodians will accept the powers but only if they are on file ahead of time, and some require their own forms.

Shrewd IRA owners will take the following steps:

§ Be sure beneficiary designations and the designation form are key elements of your estate plan.

§ Review the beneficiary designations regularly to determine if changes need to be made.

§ Keep copies of the forms and be sure beneficiaries and the executor have access to them.

§ After making changes in a beneficiary form, ask the custodian to return the old form so that there will be no confusion in the custodian’s records. Some advisors also recommend that you send two copies of the new form and have one copy stamped “received” with the date and returned to you.

§ Don’t hesitate to have your estate planner draft a custom beneficiary form and submit it to the custodian. If the custodian will not accept the customized form, search for another custodian.