Mistakes in Designating a Retirement Beneficiary

Keeping your beneficiary designations up to date is important. A problematic beneficiary designation can be frustrating for everyone involved. Still, updating is effective only if it meets certain requirements.

Beneficiary designations are particularly important for individual retirement accounts (IRAs) and employer-sponsored plans like 401(k)s; however, the paperwork and designations are typically when the account is opened, and many people might not remember who they assigned or if they assigned a beneficiary at all.

Here are some beneficiary designations that may cause problems alongside ways to avoid them through some simple precautionary steps.

Designating Unidentifiable Beneficiaries

Your custodian’s inability to identify your beneficiary could result in a delay in your intended beneficiary receiving the assets. It could also cost your beneficiary legal fees if it becomes necessary for the courts to decide who that is. Identifying your beneficiaries by name and relationship to you causes little or no problems for them; however, you do not have to put your beneficiary’s name on your designation form. Simply stating “all my surviving children,” for example, is an acceptable beneficiary designation.

In fact, the final required minimum distribution (RMD) regulations state, “A designated beneficiary need not be specified by name in the plan...in order to be a designated beneficiary so long as the individual who is to be the beneficiary is identifiable under the plan,” per Treasury Regulation § 1.401(a)(9)-4, Q&A 1. “All my surviving children” satisfies this requirement.

The designation “all my children” is also acceptable; however, should one of your children predecease you, it raises the question of how that person’s share should be handled. If you want that child’s share to go to their heirs, then you must make that intent clear in your beneficiary designation. This can be accomplished by attaching a customized beneficiary designation or by including a per stirpes clause.

Beneficiary Designations and Your Will 

Many IRA custodians are unwilling to accept beneficiary designations of “as per my will.” In many cases, the reluctance is because a will addresses the treatment of assets that are part of an individual’s estate, and a retirement account is not considered to be part of an estate.

While “as per my will” is not a widely accepted designation, the regulation suggests that it conforms to federal guidelines. Before you make such a designation, be sure to check with your IRA custodian. Even in instances where the custodian will accept such a designation, it still may not provide the desired result.

For instance, assume you provide in your will that your IRA assets should go to your daughter. She will eventually receive the assets. Instead, the IRA will be treated as having no designated beneficiary or a nonperson as the beneficiary.

Amounts Instead of Percentages 

Some individuals like to ensure that a designated beneficiary will receive a specific amount. Toward this end, beneficiary designations may be formulated to read “$80,000 to Charlie and the remainder to John.” This designation may not be an issue for accounts that at the time of the IRA owner’s death have balances significantly higher than the stated amount. Still, it could be problematic for other accounts.

For instance, assume that the IRA balance left to Charlie and John was $100,000 when the beneficiary designation was completed; however, due to a loss on investments and distributions made to meet the RMD requirement, the balance at the time of the IRA owner’s death is less than $80,000. It may seem that the only option is to give Charlie the remaining balance, but if the IRA owner wanted John to receive some of the assets, the desired results would not be achieved.

A more effective beneficiary designation would have been one that awarded each beneficiary a percentage of the assets or included alternate provisions should the balance fall below a stated amount.

IRA Beneficiaries and the SECURE Act

There are specific rules as designated by the Internal Revenue Service (IRS) regarding naming a designated beneficiary of the IRA. Spouses, who inherit an IRA, can roll over or transfer the IRA funds into their own existing individual retirement accounts. Also, they don't have to take required minimum distributions (RMDs) until they reach the age of 73 if they were born between 1951 and 1959 or 75 if they were born in 1960 or after. RMDs are minimum annual distributions that the IRS mandates for each retiree withdraw from their IRA. 

However, non-spousal beneficiaries have different rules as a result of the passage of the SECURE Act (or Setting Every Community Up for Retirement Enhancement) in 2019. Non-spousal beneficiaries can not treat the inherited IRA as if it was their own but instead, must withdraw 100% of the funds within 10 years of the original owner's death.

There are exceptions, which include disabled or chronically ill individuals and minor children. There's no annual distribution that's required as long as all of the funds have been cashed out of the IRA within the 10-year period. As a result, this can have significant tax consequences and must be considered when naming IRA beneficiaries.

The Bottom Line 

Before you submit your beneficiary designation, check with your financial advisor, custodian, or attorney to determine whether it will produce the results that you desire. If you have already submitted your beneficiary designation, you can still check its status. You should not assume that your IRA custodian will notify you if the designation is ambiguous or does not meet requirements.

In most cases, the problem is noticed only after the account owner is deceased, and the beneficiary is ready to claim the assets. By seeing that your beneficiary designation is in good order, you help to ensure that your beneficiary will be able to access the assets at any time.