Have you checked who's slated to inherit your retirement account recently? If not, you may find that your designated beneficiary is not who or what you think it should be.
If you named a charity as your beneficiary a long time ago, the charity may no longer exist. If you have divorced and remarried, your ex-spouse may still be on the form. And what if your primary beneficiary has predeceased you?
While many of us ensure that other important documents such as wills are updated on a frequent basis, we tend to forget the designations on our IRAs and 401(k)s. They're easy to overlook: After all, you filled in a name when you established the account ages ago and have had no need to look at the registration paperwork since. But to ensure your wishes are followed after you go—and to save your survivors the trauma and expense of a legal fight—check those designations periodically and keep the beneficiaries current.
- Retirement account beneficiary designations trump will and trust directives, so they need to be periodically checked and updated.
- Beneficiary designations should be reviewed immediately after major life events like getting remarried or divorced, the death of a spouse, and the adoption or birth of a child.
- There are several ways to customize beneficiary designations, regarding how assets are to be distributed.
Changing Outdated Beneficiary Designations
How do retirement accounts designations get overlooked? Sometimes it's just life —after all, if you've just had your second child, your first thought probably isn't going to be, "I've got to add her to the IRA beneficiary list, otherwise her big brother will inherit it all."
But also, people often don't realize that retirement account designations are their own separate thing. State laws vary, but generally speaking, these accounts are not governed by provisions in your will or a trust (unless you name the trust the beneficiary; more on that below).
Many a court battle has ensued because a person's will says something like "I'd like my IRA to be divided equally among my three children"—but only one of those children is actually named as the beneficiary in the IRA records. Usually, in the eyes of the account custodian (the brokerage or bank maintaining the account) and often the law as well, the designation on the IRA trumps any other directive.
To prevent these situations, you should update your beneficiary designation immediately after you experience a change in family status and review it periodically so it never becomes outdated or incorrect. Fortunately, changing your beneficiary isn't hard to do. You may revoke your existing beneficiary—and designate a new beneficiary—by submitting a change-of-beneficiary form. You can add additional beneficiaries the same way. You can also draft customized beneficiary designations to address "what-if" situations.
Request a confirmation of receipt of the designation from your retirement account trustee, custodian, or administrator. Documents do not always reach their intended recipient. Beneficiary designations are considered in effect only if they are received by the responsible party (e.g., trustee, custodian, or administrator) before the account owner dies.
Though part of your estate, your retirement accounts are generally not governed by the provisions of your will.
Default Beneficiaries: When You Didn't Designate
Custodians don't let it happen so much nowadays, but it's possible you left your beneficiary designation blank when you established the account. If you fail to document your beneficiary designation, your beneficiary may be determined by federal or state law or by the plan document that governs your retirement accounts.
For qualified plans such as profit-sharing plans, 401(k)s, and money purchase pension plans, federal regulations automatically designate the spouse of the account owner as the beneficiary. No one else may be designated as the primary beneficiary unless the spouse signs a document approving the designation and has it notarized. If the retirement account owner is not married, their estate may be the default beneficiary.
State law determines the treatments of IRAs. Some states, known as community or marital property states, require written spousal consent if the IRA owner designates anyone other than, or in addition to, their spouse. The following states require that consent to be notarized: Alaska, Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. In other states, the default provision of the IRA plan determines the beneficiary if one is not designated by the plan holder.
An IRA plan's documents also default the designation if the designated beneficiary predeceases the IRA owner. The default options vary among IRA custodians and trustees. While the default options remove administrative responsibilities from account owners, they may not reflect their preferences. This is why account owners should check the plan document and be sure they update their beneficiary designations frequently.
Many spouses, expecting that one will predecease the other, name each other as their designated beneficiaries. But what if, tragically, both die at the same time—in a plane crash, for example? The issue of simultaneous death is then addressed by state law, which will determine that one spouse died first; this determination is critical because it dictates whose will or directives govern the subsequent bequests. Again, proper account documentation designating successor beneficiaries for normal and extenuating circumstances will keep this kind of situation from arising.
Consider a Customized Beneficiary Designation
Most IRA plan documents provide default beneficiary options. For instance, if you name two individuals as your designated beneficiaries and one predeceases you, the share that belonged to the deceased beneficiary automatically goes to the surviving beneficiary. With a customized designation, you can choose how that portion would be distributed instead of having it default to the surviving beneficiary. For example, if one of your beneficiaries has children, you can designate them to receive the primary beneficiary's share if he or she passes before you do (see per stirpes designation below).
When drafting your customized beneficiary designations, you can explore various options to determine the one that meets your needs. The beneficiary designation you choose may determine if your elections are carried over to the next generation. The following are some basic beneficiary designation designs:
Per Stirpes Designation
In the event your primary beneficiary predeceases you, a per stirpes beneficiary designation provides that the share they would have received goes to their heirs. For instance, assume you name your two children, Mary and John, as your primary beneficiaries. Mary's share is 80% of the assets while John's share is 20%. Should Mary predecease you, her share would go to her heirs upon your death.
Per Capita Designation
Per capita beneficiary designations also provide that your primary beneficiary's share will go to their heirs. However, the allocations are not handled in the same manner as they are under the per stirpes designation. Should your primary beneficiary predecease you, their share would be divided equally among your successor heirs.
For instance, assume Mary and John from the previous example both predecease you. The assets will be allocated among their children equally, even though the beneficiary designation provides Mary with a larger portion of the assets. If Mary and John had two children each, each child would receive a 25% share. (By contrast, under the per stirpes formula, Mary's children would divide 80% of your IRA, each getting 40% of it. John's children would divide 20%, getting 10% each.)
If you feel you need to retain some degree of control over the disposition of the retirement assets after your death, you may consider designating a trust as your beneficiary. There are various trust options to choose from, including qualified terminable interest property (QTIP) and qualified domestic trust (QDOT).
Be sure to look into the tax implications for the kind of beneficiaries you choose, such as a spouse or non-spouse, a charity, your estate, or a trust.
Designating the right type of trust as your beneficiary can allow you to provide financial support for both your surviving spouse and children from a previous marriage. To ensure the spouse has enough to last their remaining years, some trust provisions restrict the surviving spouse's access to the assets; this can come in handy for beneficiaries who may not be financially responsible.
Trusts are complex and require the expertise of an expert to establish, to make sure they don't result in adverse tax consequences. Be sure to seek competent counsel from a trust and estates lawyer before you make any decisions regarding customized or trust beneficiary designations.
The Bottom Line
Making a proper beneficiary designation is a very important part of your financial planning. Equally important: keeping the designations up to date.
Beneficiary designations should be reviewed immediately after major life events like getting remarried or divorced, the death of a spouse, and the adoption or birth of a child. And they should be reviewed periodically, too (making a checklist of all accounts that have beneficiaries attached to them is a good idea). Fail to do so, and you run the risk of fights and a court ultimately deciding who inherits, which may not be in the way you intended.