For Smart IRA Planning, One Document Means Everything

shutterstock_143526052 (2)Of all the things you can do to protect your IRA or retirement plan from going to the wrong person or from unnecessary taxes, there is one document that trumps them all. Do you know what it is?

Your IRA beneficiary form.

Your IRA beneficiary form determines where your IRA will go after you are gone. Directly or indirectly it also determines how it will be taxed upon your death.

No matter how sophisticated your will is, no matter how much time you spent on your estate plan, it can all be for naught if your IRA beneficiary form isn’t completed correctly.

When you die, the IRA custodian must distribute your IRA to the beneficiary listed on that form. If you have listed nothing, the IRA will be distributed according to the policies of your IRA custodian. Sometimes that means your surviving spouse or children. Sometimes it means your estate. Depending on your IRA custodian any number of things can happen. The only way to know for sure is to ask them and see it in writing. Or you can simply update your beneficiary form.

For example, let’s say your will lists your current spouse as primary beneficiary and your children are listed as secondary beneficiaries. This means that when you die, everything goes to your surviving husband or wife. If they die before you, everything will go to your kids. That’s not a bad plan. For most people that works.

However, if your IRA beneficiary form still lists your ex-spouse as the primary beneficiary guess where your IRA goes. It goes to your ex. Even though you may have been married only for a short time many years ago, the IRA will go to him (or her). And there is nothing anyone can do about it.

What if you list your estate as beneficiary?

In this case, your ex-spouse may not get the IRA and it will be included in your estate, but there are two major problems with this strategy. First, when your IRA passes to your estate it becomes taxable. Depending on your tax bracket and the size of the IRA, up to half its value could be lost to income taxes. The beneficiary of your estate gets what is left.

The second major problem is that your IRA will need to go through probate. Probate isn’t the end of the world, but it takes time and costs money. Both of which could be avoided by establishing a real person as your beneficiary.

In the example above, if the IRA listed your estate as beneficiary, the IRS and your local state department of revenue take their share first. Then the remainder would go through probate and eventually find its way to your intended beneficiary many months later.

The quick fix

While an incorrect or out of date beneficiary form is a huge problem if you die, it’s an easy problem to fix while you are alive. Simply download or request a new beneficiary form from your IRA custodian or financial advisor. Update it to include the primary beneficiary of your choice – more than likely your current spouse, not your ex. Be sure to also include secondary beneficiaries such as your kids, grandkids or others.

To be sure your beneficiary designations are correct and current, I recommend reviewing all your beneficiary designation forms over the next 30 days. Review them to be sure your primary beneficiary is who you want it to be. Make sure that secondary beneficiaries are also accurate and in place. Keep your most newly updated beneficiary form on file, and store it in a safe place with all your will and other important documents.

If you have any doubts about your beneficiary designations, get a second opinion from your estate planning attorney or financial advisor.

Or just ASK MIKE.