Who Will Benefit from Your Retirement Account?

Good work! You’ve saved hard for retirement and now you’re paying closer attention to an often over-looked area – beneficiary designations.

Who gets the remaining treasure when you die? Are you sure those transfers are going to happen? Not to be cynical, consider this scenario…

You’re married and have three adult kids. You name your beloved spouse as the primary beneficiary. However, you fret over the contingent beneficiary designations. You feel confident with two of your kids – they were raised well and leading productive and responsible lives. You worry about the third – maybe unsettled, still “finding his or her way,” legal issues, or a ne’er-do-well mate – and your intuition suggests that sudden wealth would quickly vanish through their fingers.

Yet you painfully write “my living issue, equally” on the beneficiary form, and hope for the best. But don’t worry. You pass away, your beloved spouse rolls the distribution of your retirement into her IRA. And she’s named her two kids from a prior marriage, or her new partner, as beneficiaries, thereby disinheriting your kin.
Retirement planning is more than budgeting savings and picking aggressive, moderate, or conservative. Most planning issues are multi-dimensional involving financial, tax, legal, family, business, and behavioral issues. We’ll discuss major beneficiary planning considerations.

One of the reasons to rollover your retirement plan account to your IRA is to retain the residual value upon your death. Certainly, you could have elected to receive monthly benefits from your former retirement plan, including continuation of benefits to your spouse. However, upon the surviving spouse’s death, benefits generally cease. Prudent investment of the rollover might leave additional wealth. You can name various beneficiaries of your IRA – your spouse, children, charity, or trust; and each is subject to unique tax ramifications.

However, second marriages – either the current one, or your spouse remarries after your death – can create an interesting dilemma. Assuming your spouse is named as primary beneficiary, he or she can roll the IRA to their IRA and designate their specific beneficiaries. As illustrated in the example above, it didn’t matter that you had named your kids as the contingent beneficiaries.

Three possible solutions

Split your IRA into two or more with different beneficiaries – You might name your spouse as primary beneficiary of one IRA, and your kids as primary beneficiaries of the other. A disadvantage would be that your surviving spouse blows his or her IRA and they then depend upon the generosity of your children.

Modify your life insurance beneficiaries.

Prudently use trusts – Control, management and protection are the potential benefits of using trusts in your estate plan. Some situations to consider naming a trust, not individuals, as IRA beneficiaries:

• Want your kids to inherit wealth upon the surviving spouse’s death;
• One of your beneficiaries has “special needs.” Direct receipt of IRA proceeds may jeopardize qualification for disability or government benefits;
• You have minor aged children, and want to avoid the costs of court appointed/supervised conservators until they reach the age of majority;
• Situations of financially irresponsible beneficiaries and/or their protection is desired.

However, beware the tax hazards of blindly naming any type of trust as IRA beneficiary. Generally, the Tax Code doesn’t recognize a trust as an “individual” for purposes of “stretching” the tax-deferral/distributions of IRAs. Instead, the IRA proceeds may be required to be distributed within 5 years following death of the IRA owner, and the distributions may be taxed at higher rates than an individual.

Trust compliance with specific rules may accomplish two key benefits – “stretching” the IRA and keeping control out of the beneficiary’s hands. Qualifying trusts may include “IRA Look Through” or “Retirement Benefit” trusts. If a group of trust beneficiaries is named (e.g. 75 year old spouse, 50 year old son, and 20 year old granddaughter), then the life expectancy of the eldest beneficiary is used for purposes of calculating future required minimum distributions , and hence, the efficiency (or not) of the “stretch.”

Major conclusions

Find the right balance between “ruling from the grave” and “I don’t care… I’ll be dead.”

Adding sophistication has costs, including tax and legal expense, and potential burdens and strains among family members.

The payoffs can be huge including your successful retirement, tax reduction, strong family relationships and smooth wealth transfers. Get the right chiefs at the fire including your family, estate attorney, CPA, and financial advisors. The issues are complex, require special expertise, and deserve “thinking things through.”

About Brian Loy

Brian Loy writes insightful and inspiring articles about the ever-changing world of personal finance and the global trends that affect the risk and return on investments and shape the financial- and retirement-planning process.
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