Protect Your Estate Plan: Check Your Beneficiary Forms
Ben Franklin once famously noted life’s two guarantees: death and taxes. Procrastination with estate planning may be another certainty. Nobody wants to confront their mortality. However, everyone, regardless of wealth, should have an estate plan to help ensure that their assets are transferred to beneficiaries quickly, with minimal tax consequences and court costs.
While you may view your will as the cornerstone of your estate plan, it’s important to remember that there are assets that pass outside the will directly to your named beneficiaries. Proceeds from life insurance, investments in Individual Retirement Accounts (IRAs), annuities, qualified retirement plans (such as 401(k)s, 403(b)s, and SEPs), POD or TOD accounts, and trust property bypass probate and pass directly to your named beneficiary. Jointly owned property—such as your home, car, and bank and investment accounts—also avoids probate and automatically passes to the surviving co-owner.
Often overlooked in estate planning is the fact that the beneficiaries you name for assets such as IRAs and 401(k)s take priority over instructions in your will. That is, the beneficiary you named for your retirement account twenty years ago will inherit those assets even if you later specify in your will that someone else will inherit everything you own. Amazingly, the majority of your net worth could pass outside your will through your IRAs or 401(k)s to beneficiaries you have forgotten you named.
Because named beneficiaries take priority over the instructions in your will, it’s crucial that you review your beneficiary forms—all of them—on a regular basis. The following tips can help you ensure that you have properly designated your beneficiaries:
- Do not list “my estate” as your beneficiary. IRA beneficiaries should be named people in most cases. Specifying “my estate” is a mistake because estates and other legal entities don’t have life expectancies. Accordingly, when you leave your IRA to a trust, the entity must draw down and pay taxes on the entire IRA account within five years, or according to your original distribution plan if you have already begun taking distributions.
Who should you name as your beneficiary? From a tax standpoint, your spouse is usually the best choice. A spousal beneficiary has the greatest flexibility to delay IRA distributions that are subject to income tax. In addition to rolling over your IRA into his or her IRA, a surviving spouse can decide to treat your IRA as his or her own IRA. This can provide greater flexibility for long-term tax planning. However, while naming a surviving spouse can be the best move from an income tax standpoint, a possible downside could be increasing the size of your spouse’s estate beyond the 2009 applicable exclusion amount of $3.5 million. (Note, too, that many states impose a state tax on estates with considerably lower asset levels, often anything over $1 million.)
If you name a non-spousal beneficiary, such as your child, he or she will not be permitted to co-mingle the inherited IRA with another account without taking a complete distribution, which will trigger taxes. However, as a designated beneficiary, a non-spouse beneficiary can stretch out distributions over his or her own life expectancy. Because today’s tax regulations default to the stretch IRA for a designated beneficiary, most IRA custodial agreements do the same. However, there is no guarantee. Some financial institutions still restrict beneficiary options in their IRA custodial agreements or annuity contracts and might not allow the stretch IRA, so it’s wise to check those details.
- If you name a minor as a beneficiary, name a guardian. Because the courts’ view is that money left to minor should be put in a savings account until that person is age 18, there could be a situation where, for an extended period of time, a significant amount of money sits in the bank earning next to nothing. To give your beneficiary better investment options, name a guardian who can invest the money on the minor’s behalf.
- Attend to the per stirpes (1) designation. You may want to ensure that your assets go to your blood family; that is, to your children or grandchildren, rather than to your children’s spouses. However, when you explain this to a mutual fund company, often many will send a standard change of beneficiary form that may not have the essential per stirpes designation listed as an option. Often fund companies have a completely separate form for the per stirpes designation, so ask for it by name.
- Request and review your beneficiary forms every few years. If you had an IRA before you got married, it is likely you will want to change your beneficiary from your parents or siblings to your spouse. Similarly, if you have old 410(k) plans scattered around the country from jobs you held decades ago, you need to update those beneficiary forms as your personal circumstances change. Finally, with today’s high level of mergers and acquisitions, beneficiary forms could get lost. So even if you do not have any changes in your own life, it is a good idea to request copies of your beneficiary forms from your former employers and retirement plan custodians every few years.
Although you may not be ready to share the details of your estate plan with your family, you should ensure that someone knows where to find your estate planning documents. This includes your will; beneficiary forms for retirement savings programs, IRAs, and life insurance policies; your living will and power of attorney documents; and passwords to computer accounts. Mark Kaizerman’s Beneficiary Directory offers a valuable step-by-step guide to organize documents for your heirs. Of course, as your trusted financial advisor, we would be happy to hold your completed Beneficiary Directory.
Finally, be aware that estate planning during a market downturn presents both challenges and opportunities. A quick to-do list should include reviewing your will and beneficiary forms to ensure that losses in asset values of your real estate holdings or investment accounts have not resulted in an unintended, disproportionate distribution to your heirs. Also, if gifting is part of your estate planning strategy, now could be a good time to gift assets whose values have plummeted in order to minimize transfer taxes.