Today I want to stress why it is so important to review the beneficiary designation forms on your individual retirement accounts, your life insurance policies, and even your 401K at your present job. Don’t think reviewing your beneficiaries is a big deal?  Let me share a quick story of why that is so important and how one little oversight can make a huge difference for your family.

Several years ago I was conducting a first meeting with a  potential new client. The man had come in because he had inherited some money from his recently deceased mother. He was a brother of three, and was sharing with me the details of the inheritance. We started talking about that and then the story really came out about what had happen and what ripped their family apart.

Review Your Beneficiaries: Trust Me!

Their mother had a decent amount of money and it was spread out among a few different places. She had some at the bank. She had some in her IRA, and she also had some in an annuity. Whenever she set up all her beneficiary info her intent was to make sure that all of it went equally to her three sons. She even set up her will to where it would be divided into three equal parts. She just assumed that everything was okay.

Her IRA was fine. Her checking and savings accounts were fine. Her CDs at the local bank were fine. The only thing that she overlooked was the annuity. She had listed her oldest son as the primary and only beneficiary of the annuity. Now if you didn’t know this, even if you have a will and it says you want it to go into three equal parts to whomever, the beneficiary designation on that annuity overrides that. So it doesn’t matter. She just overlooked it.  Her oldest son was the executor of the will so I’m sure she just thought that the will would take care of it.

Splitting Heirs

One would conclude that even though the will said that it was to be split three different ways that oldest brother would just do what mom wanted and to split it evenly. Right? Well, he didn’t. He ended up taking all of that money to himself.

Now it probably wouldn’t have been as big a deal, but on the total dollar amount that the mom had in her entire estate with everything added up together, that annuity represented 75% of her entire estate. The brothers split everything else in three equal parts, but the annuity; that brother kept it all for himself.

It was such a large chunk of money he actually took that money and bought an airplane with it. I kid you not. Was he a pilot? No. Did he know how to fly? No. It was a hobby that he wanted to get into so instead of splitting that money with his two remaining brothers he used that to buy an airplane.

Did you catch that? An airplane.

I wish I was making this story up. It is the absolute truth and is just another reminder of why it is so important to review your beneficiaries. Remember that goes not only on annuities. That also goes to life insurance policies. That also goes to your 401K at work.  That goes for your IRA’s.

Can Happen to The Best of Us

One thing that I almost did before I was deployed to Iraq; I had just recently got married to my wife and prior to me getting married I had both my mom and my dad as my primary beneficiaries on my life insurance policies. Had I not made that important change and something happened to me, that all would have went to them and left my wife with nothing. I would like to think that my parents would have done the right thing, but I tell you what; anytime you put a big chunk of money in front of somebody that has a lot of zeros behind it you never know how they are going to act. You always want to be hopeful that they will act in the best interest, but you never know. That is why it is so important to review your beneficiaries.

Take 2-0

If you haven’t reviewed those in a while…. take a look. It takes maybe 15-20 minutes to check everything. Just jot all the things down that could have a beneficiary designation on there to make sure that you’ve reviewed it and that it is as current as you need it to be, to make sure the right people are on there. Do not pass go, go check your beneficiaries today and make sure that you’re all up to date.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.

Don't Forget About Your Beneficiaries

What’s your legacy plan?  This is a question that I often ask my clients.  I ask this for many reasons, but the main reason is to get them thinking about what happens when they are not here.  Have they taken care care of their wills, life insurance polices, and for this discussion: retirement plan beneficiaries.  I’ve already shared a few stories on the importance of your beneficiary designations, but I can’t stress this enough.  This time I want to focus on retirement plans- specifically, IRA’s, and 401k’s.

Since their introduction in the early 1970s, Individual Retirement Arrangements (IRAs) and qualified plan assets such as 401(k), 403(b), and 457 plans have become an important component of many investors’ retirement plans. While the intent of these accounts is to supplement Social Security and provide income during retirement, many affluent investors may not need or be able to spend all of the money in their retirement accounts. This creates an opportunity to leave these accounts for the benefit of heirs. This post outlines the fundamentals of beneficiary designations which are important not only in terms of leaving a legacy but also to ensure that estate and income taxes don’t unintentionally consume retirement plan assets. It should be noted that a full discussion of the tax impact of such designations is beyond the scope of this post; investors should seek appropriate counsel prior to making any investment or tax decision.

Tax Considerations

Assets in qualified retirement accounts are considered “income in respect of a decedent”. As such they are includable in a decedent’s estate on which taxes are due within nine months after death. In 2009, the maximum federal estate tax is 45%, and the exemption equivalent amount is $3.5 million. In an estate where the qualified account is a sizable estate asset, depending on who is the account beneficiary (for example a non-spouse which does not qualify for the marital deduction), without advance planning for payment of estate taxes the account might have to be liquidated to pay them. This distribution could in turn trigger an income tax liability to the beneficiaries. (Note that there is an income tax credit available to beneficiaries for estate tax paid.) With proper beneficiary planning, this can be minimized or avoided.

Definition of Beneficiary

As illustrated  below, beneficiaries of qualified accounts are considered to be either “designated” or not. A designated beneficiary is a living person for whom a life expectancy can be calculated. A non-designated beneficiary (called simply a “beneficiary”) is anything else. This is a critical distinction in determining how the assets are paid out of the account.

Designated Beneficiary

A designated beneficiary can be further classified into two types — the spouse and everyone else (“non-spouse”) In some situations, trusts can be considered designated beneficiaries, assuming they are set up correctly.

Spousal Beneficiaries

The account owner’s spouse is usually listed as the beneficiary of the account upon the account owner’s death. In fact, in many cases, the spouse has to approve the designation of an alternative beneficiary. As a beneficiary, the spouse has four options allowed by the IRS:

1. Leave the money in the account.
2. Take a lump sum distribution.
3. Take an annuitized distribution based on their life expectancy.
4. Roll the assets over into their own IRA account.

This last option is only available to a spousal beneficiary, and is often called a “Spousal Rollover”.

Non-spousal beneficiaries

A non-spousal beneficiary could be children, grandchildren, nieces, nephews, or any other living person the account owner chooses. These beneficiaries have three distribution options allowed by the IRS:

1. Leave the money in the account.
2. Take a lump sum distribution.
3. Take an annuitized distribution based on their life expectancy.

Non-spousal beneficiaries cannot roll the account into their own account as a spouse can. One very popular strategy for non-spousal beneficiaries is the third strategy – taking distributions based on life expectancy. This is often called the “Stretch IRA”, and for a child beneficiary they can stretch the distributions into the future for as long as they are expected to live– 30, 40, or even 50 years — depending on their age when the account owner dies.
There are two primary benefits to this strategy:

1. Most of the money remains in the account, and grows on a tax-deferred basis,
2. The beneficiary only pays income tax on the amount that comes out each year, stretching out their income tax liability over many years, instead of having to pay it all at once if a lump sum distribution is taken. (If estate tax has been paid due to income in respect of a decedent, a pro-rated income tax deduction is allowed the beneficiary. Contact a tax advisor for more information.)

Non-Designated Beneficiaries

Non-designated beneficiaries include any beneficiaries for whom a life expectancy cannot be determined, such as non-qualified trusts, charities, and the decedent’s estate. Qualified accounts with non-designated beneficiaries must be distributed either within 5 years of the owner’s death if they die before attaining age 70½ or, if the owner had already attained age 70½ and was receiving required minimum distributions, these must continue until the account is depleted.

Multiple Beneficiaries

It is possible, and quite common, to have more than one beneficiary identified for a qualified account. IRS rules issued in 2002 have made planning for this situation much easier. Beneficiaries now have a “Gap Period” between the date of death of the account owner, and September 30th of the following year, called the “Designation Date”, in which to separate the account for each beneficiary. This provides beneficiaries more flexibility in their planning and the opportunity to take distributions as they wish.

Hypothetical Example of “Gap Period”

For example, if an account listed 3 beneficiaries, two children and a charity, and the accounts were not split before death or during the Gap Period, the account would have to be completely distributed within 5 years of the owner’s death because the charity is a non-designated beneficiary. This would cause an income taxable event for the beneficiaries more quickly than they may have wished. However, if the account were split into three separate accounts, one for each beneficiary, the charity’s portion would go to the charity, and each child would be able to decide how they wanted to have the money distributed, including taking it out as a Stretch IRA, based on their individual life expectancy.

Other Planning Considerations

• Ensure that contingent beneficiaries are named. Beneficiaries cannot be named after the death of the owner/participant, and if the primary beneficiary is dead, and no contingents are named, the estate becomes the beneficiary and the account must be distributed within 5 years.
• Ensure that beneficiary designations are current on all of retirement accounts as changes may be necessary due to births, deaths, marriages, and divorces.
• Coordinate beneficiary designations on all qualified accounts with those listed in their will or in their estate planning documents. Beneficiary designation forms control who legally is entitled to the account, not the will.

photo by .bryan.stupar.