Financial services firms are lagging behind the IRS in making it easier to pass IRA wealth to succeeding generations. Because of this, the key estate planning document used in wealth transfer plans frequently is a time bomb. It is neglected or isn’t properly completed.
The beneficiary designation form is the key document for passing on wealth held in an IRA or other qualified retirement plan. Nothing in your will controls how a retirement plan is transferred. Many people completed the form years ago when an IRA was opened or they first signed up for the company retirement plan. They haven’t considered the form since.
The IRS revised the regulations for required minimum distributions and the designation of beneficiaries in 2001 and 2002. These changes made it easier to compute the distributions and to make an IRA last for a couple of generations.
Financial firms that sponsor IRAs continue to stick with the basic beneficiary designation form. This basic form asks you to list the main beneficiary or beneficiaries plus a contingent beneficiary or beneficiaries in case the main beneficiary passes away. Often, there is room for only one name for each beneficiary category.
The standard form is inadequate for many people today. Longer life spans, multiple marriages, and blended families lead to more complicated situations than can be handled on the basic form. The forms were developed when the maximum IRA contribution was $500. Now, IRAs contain substantial rollovers from 401(k) accounts and other retirement plans.
If you do not name a beneficiary, your estate is treated as beneficiary of the IRA. As we’ve discussed in past visits, this is perhaps the worst situation. The IRA will be included in your estate. In addition, the balance of the IRA must be distributed and subject to income taxes as soon as possible. Only a small percentage of the IRA would make it to your heirs after taxes.
The standard beneficiary designation form is useful only when there is a simple IRA transfer. If you want to leave the account to your spouse with an adult child or children as contingent beneficiaries, the standard form is fine. In many other situations, the form is not sufficient. It is not useful when you lengthen the life of the IRA by leaving it to the grandchildren or splitting it unevenly among the adult children. It also is not useful when you want to provide for your spouse but also want to control who gets it after your spouse passes away.
In these more sophisticated situations, estate planning advisors will draft a customized beneficiary designation form to be filed with the IRA custodian. Some estate planning peovessionals call this a Retirement Asset Will. This document spells out the order in which beneficiaries will take ownership of the IRA and the proportion each will own. The document can designate ownership for several generations.
A custom form also should be used when a minor is named as a beneficiary or contingent beneficiary. That is because there must be a guardian named for the minor. If you do not name the minor, a court must appoint one. The court might also require the guardian to post a bond and have the court approve investment decisions. The rules depend on you state.
If you use a customized beneficiary designation form, be sure the IRA custodian will honor it. Not all IRA custodians accept non-standard forms. Some accept them only for accounts above a certain value. When sending the form to a custodian, send two copies and include a return envelope. Ask the custodian to put a date stamp on one copy and mail it back to you.
Another option is to name a trust as the IRA beneficiary, and some estate planners prefer this to the customized beneficiary designation form or combine the two approaches. Naming a trust as beneficiary puts the trustee and trust agreement in charge of the account and simplifies things for the IRA custodian. A trust also is the best way to ensure that the IRA does not end up with the spouse or children of a subsequent marriage by your spouse.
Trusts have to be written carefully to ensure the intended tax results. Be sure to have an experienced estate planning attorney draft any trust that will be beneficiary of a retirement account.
Beneficiary designation forms should be updated as part of the estate planning process and should be reviewed every couple of years with the rest of the estate plan. You must decide who will inherit the IRA and what the tax consequences will be. Then you must be sure that the correct forms are used to implement the plan.