Why are IRA Beneficiary Designations So Important?

Edited by Bob Brumfield

If you pass away without naming beneficiaries in your will, it can create legal entanglements for your heirs.

If you decide to purchase a life insurance policy or to put some money into a new deferred annuity contract or Individual Retirement Account (IRA), you need to complete the beneficiary form.

However, Investopedia’s recent article entitled “Why Your Will Should Name Designated Beneficiaries” says that you may just name a person as a beneficiary, without fully appreciating this aspect of your estate planning.

First, it’s important to understand what generally happens to your possessions and property after you die. If you have a will, your family must still go through probate to receive what you’ve left them. If you die intestate (without a will), your possessions become part of your estate, and intestacy laws will dictate the distribution.

If you name designated beneficiaries, you list who will get the money and what percentage each will receive. Then, after you die, your beneficiaries present a death certificate to a bank and complete a form. For certain assets, there’s no probate, no court involvement and no expense.

When completing a beneficiary form, you should consider not only who will get the money in your accounts, but how they’ll get it. If you’re worried that your beneficiaries couldn’t handle a large lump-sum payment, there are other options. Most annuity and life insurance companies now have a form that allows contract owners to designate how beneficiaries receive the death benefit. Generally, they offer three payment options: (i) a lump sum; (ii) a certain period of time; and (iii) amortization over the beneficiary’s life expectancy.

You could also divide the benefit, so your beneficiaries get some as a lump sum with the rest in scheduled payouts. However, note that your IRA might not have the same type of beneficiary payout options as annuities and life insurance do. The standard beneficiary form you complete when you open the account, usually only requires that you name a primary and a secondary beneficiary.

Other than that, the custodial institution’s policy will determine how funds get paid out to your heirs.  It is, therefore, possible that your biggest financial asset will be covered only by a simple, one-page document that may not truly express your intentions about who should inherit the retirement funds or how they should get them.

Another issue is if you’re single with three grown children, and you name each one an equal beneficiary on your IRA. One of the three dies. Shortly thereafter, you die, and the custodian’s policy is that the two living children should inherit the deceased child’s share. However, that’s not what you wanted. You wanted the deceased child’s family to get their father’s share. This result could have been avoided with proper estate planning. Ask an estate planning attorney about this.

Review the IRA custodial agreements on your accounts. Make sure that you understand the agreement’s policy on areas such as stretch distributions, beneficiaries designating a beneficiary, customized beneficiary forms, trustee-to-trustee transfers, non-spouse beneficiaries moving investments after the owner’s passing and any default provisions, in case a beneficiary predeceases you and you fail to make subsequent changes.

About the author

Bob Brumfield

Attorney Bob Brumfield has been practicing law since 1984 and regularly receives the “Top Lawyers in California” award as well as the “Client Distinction” and “Client Champion” awards from Martindale-Hubbell.

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