Nine Important Questions to Ask IRA Custodians

IRA custodians are not all the same. Most people know that and do some comparison shopping before they select a custodian. The comparisons usually end with fees and investment choices. But other IRA issues can matter more and can dramatically affect the percentage of your IRA that benefits your heirs. A custodian needs to be asked about these other issues to ensure it is compatible with your estate plan and the needs of your heirs.

Many people do not realize that an IRA custodian does not have to allow you to take all the actions allowed under the tax law. The custodian can impose limits in addition to those set by the tax law.

Here are some issues to discuss with your custodian or with prospective custodians. In addition to these issues, ask your estate planner if there are other issues that are essential or helpful for your estate plan. If a custodian does not allow the flexibility you want or need, switch to another custodian.

May heirs move? Some custodians will not allow beneficiaries who inherit an IRA to transfer that IRA to another custodian. The only options these custodians allow are to leave the IRA where it is or take a distribution. Your heirs should be able to move the IRA to the custodian of their choice. They might prefer a custodian with lower costs, different investment choices, or that already holds their other accounts. There is no reason for an IRA to be locked into one custodian, though it is reasonable to charge a modest fee for the transfer.

Spousal rollovers. A similar obstacle is placed in front of some spouses who inherit IRAs. The tax law allows an IRA that was inherited by a spouse to be rolled over into a new IRA in the inheriting spouse’s name. That allows the inheriting spouse to start fresh with new beneficiaries and a new distribution schedule. The IRA is treated as though the inheriting spouse owned it all along.

In exercising this right, the inheriting spouse might want to rollover the IRA to a different custodian. Some custodians make this difficult. They will assist in a rollover only if the IRAs have identical titles. That means they won’t rollover the deceased’s IRA into one in the spouse’s name at another custodian. Instead, the spouse has to open a new IRA at the current custodian and transfer the inherited IRA into that. Only after that can the account be rolled over to an IRA at another custodian. A bereaved spouse shouldn’t have to go through such hurdles, and they seem to be designed to discourage the rollover to a new custodian.

Multiple IRAs. Most IRAs have more than one beneficiary. For example, all of the owner’s children might inherit equal shares. IRS regulations issued in 2002 allow co-beneficiaries to split the IRA into separate IRAs for each of them. That allows each beneficiary to set his or her own distribution schedule and control the investments.

Not all custodians allow the IRAs to be split. Some do not want the expense of maintaining the separate accounts. If your IRA has more than one beneficiary or contingent beneficiaries, be sure the custodian will allow the account to be split into multiple IRAs.

Name changes. The tax law has some details that can trap the unwary and trigger immense taxes. One trap regards the name or title of an inherited IRA.

Except for when a spouse inherits an IRA, the beneficiary has to keep the deceased’s name on the IRA to avoid having to take a taxable distribution of the entire amount within a short period. The IRA has to include both the deceased’s name and the beneficiary’s. An appropriate title for the inherited IRA is: “Max Profits, deceased, for the benefit of Hi Profits.”

Not all custodians know this. Some automatically change the IRA’s title to only the name of the beneficiary. That requires a taxable distribution. If your beneficiary plans to take out all the money and spend the after-tax amount, this doesn’t matter. But a beneficiary who wants to take advantage of the IRA’s tax deferral needs a different custodian.

Distribution schedule. When the deceased already began required minimum distributions from an IRA, the inheriting beneficiary has the right to continue that schedule. But some custodians automatically distribute the balance to the beneficiary or impose an accelerated distribution schedule. Be sure a custodian understands the rules and allows your beneficiary to take full advantage.

A trust as beneficiary. Naming a trust as an IRA beneficiary always has been a difficult issue. The regulations issued in 2002 made the rules clearer. But a trust inheriting an IRA is allowed tax deferral only in limited circumstances. The trust terms are key to determining whether deferral is available.

Some custodians don’t know the nuances of the rules or are cautious when interpreting the rules. When a trust is beneficiary, these custodians require distributions either immediately or within five years. Most of you won’t name a trust as beneficiary, and I generally do not recommend it because of the tricks and uncertainties in the law. But if your estate planner has worked through the technicalities and named a trust as beneficiary, be sure you have a custodian who will follow through.

Estate as beneficiary. Naming your estate as beneficiary or failing to name a beneficiary (which automatically makes your estate the beneficiary) is a bad idea. The estate does not qualify for the best tax deferral possibilities. If you were not taking the required minimum distributions, the IRA must be distributed within five years. If required minimum distributions already had begun, the distributions can begin on your schedule. But the beneficiaries’ of the estate cannot take distributions using their own life expectancies.

The custodian might make the situation even worse. It might insist on making all payments to the estate, even if the estate notifies the custodian that certain individuals are the beneficiaries of the estate. That means the estate must remain open and file tax returns for as long as distributions are being made from the IRA. That is unduly restrictive. The IRA can be assigned by the estate to a beneficiary named in the will, established by law, or set in other ways. A custodian should recognize this and make things easier on the beneficiaries.

Executor communications. An IRA usually is not affected by a will or other estate documents. The only thing that matters is the beneficiary designation form filed with the custodian. Yet, the estate executor needs information the custodian has. For example, the executor needs verification of the IRA’s value for the estate tax return. If the custodian will not work or communicate with the executor, the surviving spouse or other beneficiary has the burden of being a middle man between the custodian and the executor. It is better to have a custodian who will communicate with the executor after receiving documentation of the executor’s authority.

Customized forms. The standard beneficiary designation form does not work for all IRA owners. The current regulations often make it wise to name multiple beneficiaries who will inherit different percentages or a number of contingent beneficiaries. In these and other situations, the estate planner finds it prudent to draft a custom beneficiary designation form and submit it to the custodian.

Often, drafting the form is the easy part. The estate planner or IRA owner needs to contact the custodian and be sure that the form will be accepted. Some custodians want specific formats or want their own legal counsel to review the details. A few custodians will not accept custom forms. Some custodians require a clause relieving the custodian of liability if it follows the directions in the form.

Even after the custom form is accepted, the owner should periodically receive assurance that the form still is on file and connected with the IRA. The owner, the estate executor, and the estate planner should keep copies of the beneficiary form in case the custodian loses the form. Lost beneficiary forms are not unusual, especially with all the mergers in the financial services industry. If a custom beneficiary designation form is changed, ask the custodian if it will return the old form.

If a custodian is resistant to your needs, sometimes expression of an intention to transfer the IRA is sufficient to get the desired action. Other times, it is best to transfer the IRA to a custodian with more favorable policies.

Even after being satisfied with a custodian, someone involved with your estate who is knowledgeable about the IRA needs to monitor the custodian’s actions. Custodians make mistakes. It might, for example, simply close the IRA and issue a check to the surviving spouse. If not fixed promptly, the IRS might not allow a remedy. The beneficiary might have to pay thousands of dollars in taxes.

Don’t let the custodian be the leak that sinks your estate plan. Verify the custodian’s policies now, and be sure there is someone who will ensure that the follow-through is correct.