Beneficiary Designations....A Trap for the Unwary

Each year more and more wealth is transferred at death in the form of IRAs and other retirement accounts.  These transfers are not processed through courts in the probate process, but are transferred directly by the custodian pursuant to the beneficiary designations set forth as part of the owner's contract with that custodian.  There can be big problems with those designations.

One set of problems occur because the owners of these IRAs and 401Ks, etc. are human and forget what they did years ago.  For example a young person with a young family starts his career with a great company who s/he will have a 30-40 year career.  As part of the employment process s/he will complete the papers/contract to establish a 401K retirement plan.  S/he will name his or her spouse as primary beneficiary, but in the event of the death of both the employee and spouse the two children then living will inherit the 401K.  The next year another child is added to the family and the year after another.  Three or four decades pass and the two children born after the 401K was established are never added to the beneficiary designation.   40 years after starting to work, the employee meets with an attorney to prepare estate planning documents.  The attorney asks the employee about the beneficiaries designated for the 401K.  The employee responds that the spouse is the primary and "all" the children will inherit if the employee and spouse die.  This is a far too frequent scenario.  People are quite sure that they have named all the children in the designation made decades ago, since that is what they intended and they correctly remember naming some of the children.   WHEN REVIEWING ESTATE PLANS ALWAYS OBTAIN A COPY OF THOSE DESIGNATIONS AND READ THEM....you very well may be surprised.

Recently I read an article in the Wall Street Journal titled, "The Hazards of Inheriting an IRA."  See  http://online.wsj.com/news/articles/SB10001424052702303743604579350721159978040?mg=reno64-wsj&url=http%3A%2F%2Fonline.wsj.com%2Farticle%2FSB10001424052702303743604579350721159978040.html

This article introduced another set of problems in beneficiary designations.  These problems occur when people roll over a retirement account or change the investment which in the company records ends up actually creating a different account with a different number.  The problem with many of these changes is that they are within the same company and are viewed by the investment adviser and the account owner as simple changes that do not require the filling out of all the papers such as beneficiary designations.  Unfortunately the IRS and the courts view these "minor" changes as completely different accounts, so the prior beneficiary designations are no longer effective.  WHEN REVIEWING ESTATE PLANS ALWAYS OBTAIN A COPY OF THOSE DESIGNATIONS AND READ THEM.......BE SURE THAT THE ACCOUNT NUMBERS ARE THE SAME ON THE BENEFICIARY DESIGNATION AND ON THE CURRENT ACCOUNT STATEMENTS.  IF THEY ARE DIFFERENT, AND THE COMPANY SAYS ITS OK, VERIFY THAT WITH AN INDEPENDENT TAX ADVISER.

It is also a great idea to give copies of these designations to all the persons named so that they will be able to enforce them after the death of the owner of the account.

The Journal article also alerts the reader to many problems that may arise after these retirement accounts are inherited.  Those problems include:  withdrawal deadlines that are enforced with steep penalties,  special rules for spouses,  problems that may occur in retitling these accounts, etc.  It is my opinion that when a retirement account is inherited, the recipient should consult with a tax expert to make sure that everything is done correctly.  The information contained in the Journal article is just enough to alert us to some of the dangers, but not complete enough to allow us to navigate this territory unaided.

Posted on February 1, 2014 .