Avoid This Major Mistake When Adding an IRA to Your Estate Plan
Some people assume that because they’ve named a specific heir as the beneficiary of their IRA in their will or trust that there’s no need to list the same person again as beneficiary in their IRA paperwork. Because of this, they often leave the IRA beneficiary form blank or list “my estate” as the beneficiary.
But this is a major mistake—and one that can lead to serious complications and expense.
IRAs aren’t like other estate assets
First off, your IRA is treated differently than other assets, such as a car or house, in that the person you name on your IRA’s beneficiary form is the one who will inherit the account’s funds, even if a different person is named in your will or in a trust. Your IRA beneficiary designation controls who gets the funds, no matter what you may indicate elsewhere.
Given this, you must ensure your IRA’s beneficiary designation form is up to date and lists either the name of the person you want to inherit your IRA, or the name of the trustee of your trust, if you want it to go to a revocable living trust or special IRA trust you’ve prepared. For example, if you listed an ex-spouse as the beneficiary of your IRA and forget to change it to your current spouse, your ex will get the funds when you die, even if your current spouse is listed as the beneficiary in your will.
Moreover, not naming a beneficiary, or just naming your “estate” in the IRA’s beneficiary designation form, means your IRA account will be subject to the court process called probate. Probate costs unnecessary time and money and guarantees your family will get stuck in court.
When you name your desired heir on the IRA beneficiary form, those funds will be available almost immediately to the named beneficiary following your death, and the money will be protected from creditors. But if your beneficiary has to go through probate to claim the funds, he or she might have to wait months, or even years, for probate to be finalized.
Plus, your heir may also be on the hook for attorney and executor fees, as well as potential liabilities from creditor claims, associated with probate, thereby reducing the IRA’s total value.
Reduced growth and tax savings
Another big problem caused by naming your estate in the IRA beneficiary designation or forgetting to name anyone at all is that your heir will lose out on an important opportunity for tax savings and growth of the funds. This is because the IRS calculates how the IRA’s funds will be dispersed and taxed based on the owner’s life expectancy. Since your estate is not a human, it’s ineligible for a valuable tax-savings option known as the “stretch provision” that would be available had you named the appropriate beneficiary.
Typically, when an individual is named as the IRA’s beneficiary, he or she can choose to take only the required minimum distributions over the course of his or her life expectancy. “Stretching” out the payments in this way allows for much more tax-deferred growth of the IRA’s invested funds and minimizes the amount of income tax due when withdrawals are made.
However, if the IRA’s beneficiary designation lists “my estate” or is left blank, the option to stretch out payments is no longer available. In such cases, if you die before April 1st of the year you reach 70 ½ years old (the required beginning date for distributions), your estate will have to pay out all of the IRA’s funds within five years of your death. If you die after age 70 1/2, the estate will have to make distributions over your remaining life expectancy.
This means the beneficiary who eventually gets your IRA funds from your estate will have to take the funds sooner—and pay the deferred taxes upon distribution. This limits their opportunity for additional tax-deferred growth of the account and requires him or her to pay a potentially hefty income tax bill.
A simple fix
Fortunately, preventing these complications is super easy—just be sure to name your chosen heir as beneficiary in your IRA paperwork (along with a couple alternate beneficiaries). And remember to update the named beneficiary if your life circumstances change, such as after a death or divorce.
With us as your Personal Family Lawyer®, we can help you select the ideal beneficiary for your IRA and other estate assets. What’s more, we have systems in place that will ensure your designated beneficiary form is always up-to-date with the correct heir listed should your life circumstances dictate a change. Call us today to get started.
This article is a service of Lori R. Somekh, Esq., Personal Family Lawyer®. We don’t just draft documents; we ensure you make informed and empowered decisions about life and death, for yourself and the people you love. That’s why we offer a Family Wealth Planning Session, ™ during which you will get more financially organized than you’ve ever been before, and make all the best choices for the people you love. You can begin by calling our office today to schedule a Family Wealth Planning Session and mention this article to find out how to get this $750 session at no charge.
Somekh & Associates, PLLC,
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