Check Your Retirement Plan Beneficiary Designations!

By Harry S. Margolis

Yes, I know, checking your retirement plan (IRA, 401(k), etc.) beneficiary designations ranks right up there with dental work and cleaning your gutters as fun activities.  But it’s at least as important.

There are some ironies here.  Clients will spend good money and good time to plan their estates, including wills and trusts, and pay little attention to their retirement plan designations even though, in many cases, these retirement plans make up a good part of their estates.

To compound the irony, every state has stringent rules about the formalities for executing a will, but none for beneficiary designations, which may ultimately direct the distribution of a larger part of your estate.

Here are a few pitfalls that can occur if the beneficiary designation is not right:

  • Plans with no beneficiary named are payable to the owner’s estate, meaning the estate needs to be probated, which might not have been necessary otherwise, and that the funds must be withdrawn over the subsequent five years, rather than over the lifetime of the beneficiary.  The quicker withdrawal schedule results in the beneficiary losing the investment benefit of earnings on the funds that have now been used to pay taxes.  In addition, the larger withdrawals may push the beneficiary into a higher tax bracket, resulting on their being taxed at a higher rate.

  • If the person designated dies before the plan owner (and no alternate is named), the account will go to the owner’s estate and it will have to be drawn down and taxes paid on it much more quickly, losing the benefits of deferring taxes.

  • Some plan owners get divorced and never change the beneficiaries designated on their accounts, with obvious results.

  • A further possible downside of an IRA going to one’s estate rather than directly to beneficiaries is that it may become subject to creditors claims that it would have otherwise avoided.

  • In some cases, the wrong beneficiary has been named.  If, for instance, an individual had a falling out with his children after getting happily remarried, he may not want them to receive his retirement plan upon his death.

  • Sometimes people make mistakes such as naming a spouse’s retirement plan instead of the spouse herself as the beneficiary.  Since only individuals may be designated beneficiaries of retirement plans, this would require early withdrawal of the funds in the account.

  • Similarly, naming the wrong kind of trust as the beneficiary would lead to similar results.  Trusts may be drafted so that the trust beneficiary is treated as the designated beneficiary of the retirement plan, but this takes care and particular terms in the trust.

In short, retirement plan beneficiary designations need the same care, attention and review as most clients and attorneys take when preparing the rest of clients’ estate plans — wills, trusts, powers of attorney, etc.

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