Do you have an IRA or a 401(k)? You probably do. You may have both of these retirement savings accounts in your portfolio, or accounts that are similar.
While IRAs and 401(k)s are commonplace, many IRA owners and 401(k) plan participants have a hard time answering a common question. They aren’t sure who they have named as the account beneficiary.
Who have you chosen to inherit those funds? Can you imagine what would happen if the money in your IRA or 401(k) went to someone you were estranged from? Or if your heirs found out that you never named a beneficiary in the first place?
This occurs more often than you might think – and a little attention to detail today may help to prevent surprise or disappointment later.
When was the last time you looked at your beneficiary forms? Decades may have passed since you opened that IRA or enrolled in that 401(k) plan. Back then, you presumably filled out a form stating who you wanted those assets to go to if you pass away. Even factoring in the hunt for a beneficiary’s Social Security number, it might have taken you all of ten minutes to complete.
In that moment, you may have made one of your biggest estate planning decisions. You need to make sure your decision is still the right one.
What takes precedence - a will, a family trust, or a beneficiary form? In all but rare situations, the beneficiary form comes first. If you die, your IRA or 401(k) custodian (i.e., the investment company that hosts your retirement savings account) will determine who gets the assets in your IRA or 401(k) per your request stated on the beneficiary form. Whatever you state in your will or living trust will be legally irrelevant barring exceptional circumstances.1
IRAs and 401(k)s commonly have primary beneficiaries (first in line to the assets) and contingent beneficiaries (second in line, third in line, etc.). The important thing is to have the beneficiary designations up to date.
Plan to avoid IRA pitfalls. Here are two of the worst-case scenarios when it comes to outdated beneficiary decisions.
*Mike and Veronica got married in 1996 and Veronica opened an IRA that year. They divorced in 2002. Veronica would like for her IRA assets to pass to her daughter Yvette when she dies. However, Yvette was not yet born when Veronica opened the IRA, and so Mike is its designated primary beneficiary. She has not spoken to Mike in five years and wants nothing to do with him, yet he is first in line to receive her hard-earned retirement savings should she pass.
*Harrison opened an IRA in 1998. Today, that IRA is quite sizable – yet for some reason, there has never been a designated beneficiary for it. Unexpectedly, Harrison dies. Since there is no designated beneficiary, the IRA custodian decides how those funds will be distributed per its default policy. The brokerage firm first directs the IRA assets to his wife, then to his estate. Harrison wanted that money to go to his two daughters and even privately told them that he wanted them to receive it, but as he overlooked or never indicated his wishes on the beneficiary form, the outcome is different than what he had in mind.1
Things are a bit less tangled with 401(k)s. If a 401(k) plan participant dies, the spouse is the primary beneficiary – it is federal law. So the spouse will inherit the assets, unless he or she earlier waived rights to them on the beneficiary form or another form. What if the plan participant isn’t married? Some 401(k)s will permit the assets to pass to a plan participant’s children if no spouse is alive and no beneficiary form can be found.1
I’ll help you review your IRA & 401(k) beneficiary designations – for free. It is vital to make sure that your IRA or 401(k) money will go where you want it to go if you pass away. As a free service to the community, I provide beneficiary reviews and explain a lot of the “fine print” when it comes to the timeline of the assets distributions. I also let people know about their options when they inherit IRA funds or 401(k) funds – you have to be very careful, because there can be big tax consequences if you make careless moves. Call, email or get the Beneficiary Form Checklist here – I’m happy to help out.
1 www.forbes.com/forbes/2010/0628/investment-guide-stretch-ira-beneficiary-five-rules-inherited-iras.html1 [6/28/10]
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