5 IRA beneficiary form mistakes to avoid
For many retirees, individual retirement accounts are their single largest asset, a financial war chest meant to supplement their income during their lifetime and provide for their heirs once they're gone.
Yet, all too often IRA owners commit costly errors on their beneficiary form that negate their best intentions, leaving loved ones out in the cold.
From failing to update their document after a divorce, to forgetting to name a beneficiary, such financial fumbles can force future generations to surrender too much to Uncle Sam -- or worse, deny them their rightful inheritance.
"It happens more often than you'd think," says Certified Financial Planner professional Joel Larsen, a principal with Navion Financial Advisors in Davis, Calif. "Otherwise capable and intelligent people don't always do proper estate planning because they don't want to address their own mortality."
Perhaps the most common mistake when it comes to designating an IRA beneficiary is forgetting to update your beneficiary form after you divorce or remarry, or when the person you intended to pass your assets to passes away before you.
Your beneficiary form should be reviewed and updated after every life event, says Neil Brown, CFP professional and CPA with Burkett Financial Services in West Columbia, S.C. Updating your will is not enough.
"The IRA beneficiary form overrides your will," says Brown.
Indeed, if you get remarried and change your will, but forget to amend your IRA, the person named on your IRA beneficiary form (most likely your ex) would be legally entitled to your assets when you die -- and, thus, able to pass that money along to any children he or she had from other marriages.
"Retirees can very easily leave their IRA to someone not within their wishes, or leave it to someone within their wishes, but with very negative tax consequences," says Brown, noting many of his clients have insisted that their beneficiary forms are "taken care of" only to discover on closer inspection that their ex-spouse was still named as sole beneficiary.
Naming your estate
This is the biggest blunder of all.
Those who name their estate as their IRA beneficiary, or who inadvertently do so by failing to select a beneficiary, deprive their heirs of a significant growth opportunity.
Normally, nonspouse beneficiaries who inherit a traditional IRA can choose between two options: Either liquidate and pay taxes on those assets within five years of the owner's death, or "stretch" their required minimum distributions out over their lifetime.
"Too many people do not understand the significance of a beneficiary form and leave them blank or name their estate," says Brown. "This is a complete mistake because it limits the beneficiaries' ability to stretch the IRA after the owner's death. It speeds up the income taxes on the distributions as well and can amount to hundreds of thousands of lost growth potential."
Another negative to not naming an IRA beneficiary: The probate court would consider that asset to be part of your estate after you die, and thus it would be subject to any creditors.
If that's not enough, your IRA would also not be distributable to your heirs until the probate process concludes, which can take more than a year.
Do your family a favor and be sure you've named an actual person as your beneficiary, not your estate.
No financial controls
Another IRA no-no is naming your child as sole beneficiary without establishing controls, especially if she lacks financial sophistication.
After you die, the money in your account belongs to your beneficiary. She can spend it however she likes -- on a college education, a down payment on a house, or at a tattoo parlor in Tennessee.