Will Your IRA Money Really Go Where You Want it to?

Every week, more than 28,000 people reach the age where they must begin to take mandatory IRA distributions.  When the IRS “simplified” the IRA distribution rules in January 2001, many people mistakenly assumed that the process of distribution planning would now be simpler and that detailed planning was less necessary. 

This couldn’t be further from the truth.  The new rules have not, in fact, made planning simpler; in truth there are many significant errors in distribution planning that could prevent your legacy from ending up where you really want it to go.

Common beneficiary designation errors

When most people select beneficiaries for their IRAs, they select their spouse or their children.  As simple as this seems, it can create problems.  Consider these two scenarios.

When a plan owner leaves an IRA account to the spouse, it inflates the spousal assets. And when the spouse later dies with an estate exceeding $1.5 million (the estate exemptions limit in 2005), they pay estate tax.  By leaving the IRA to the spouse, the deceased spouse has created unnecessary estate taxes by making the survivor’s estate larger.

So instead, they leave the IRA to the son.  But as indicated before, this leaves the son total control over the asset.   He may withdraw the funds immediately and decide to buy a mansion jointly with his spouse (whom they can’t stand).  To complete their misery, let’s say that the following week, the daughter-in-law files for divorce and gets to keep the mansion in the settlement.   Mom and Dad just gave the despicable daughter-in-law a mansion with their IRA money.   Even in death they have money problems.

To avoid the above two scenarios, they decide to leave the IRA to the “estate.”   Many attorneys advise that you never leave a retirement plan to your estate, because at death, the IRS requires the account to be rapidly distributed rather than allowed to stretch over the lifetimes of beneficiaries.  Additionally, the IRA will now be a probate asset and subject to claims of creditors.

They leave their IRA in a trust and appoint a trustee like an accountant, financial advisor, attorney, etc., a person that has good common sense and tax knowledge.

Within the boundaries of Mom’s and Dad’s wishes and IRS-required minimum distributions, the trustee will determine who among the beneficiaries will get the IRA and how much they get.  The trustee will determine how quickly this money gets distributed over and above the annual minimum amount of required IRS distributions.   Mom and Dad can even give very detailed instructions.  For example, they could dictate no distributions for purchases of homes with the despicable spouse.   Or if the money is to be used for education they may stipulate that up to $15,000 a year can be distributed, or to start a business up to $25,000 can be distributed, and they can go on and on delivering very specific instructions. 

Perhaps this particular scenario doesn’t apply to your situation.  That doesn’t mean that your assets are as protected as you think.  Read on:

You probably need an IRA Asset Will

Many plan owners don’t consider what happens if their beneficiary pre-deceases them.

 Let’s say you have two sons, Jack and Tom that have been named as the primary beneficiaries for their IRA on the  “IRA Beneficiary Designation Form” on file at the bank or securities firm that holds the account.

As shown in the above illustration, Jack and Tom each have a son.  Jack’s son is Bob. Tom’s son is Dan.  So you write the grandsons’ names on the line of the beneficiary designation form that says “secondary beneficiaries.”

If Jack dies before you, the owner of the plan assets, do you assume that Jack’s share will go to his son, Bob?  Wrong.

It will go to Tom, because on the beneficiary designation form, there is no place to specify how the primary beneficiaries and secondary beneficiaries are related. There is no place for you to explain your intentions or write “per stirpes” to clarify intentions with respect to those beneficiaries.  Those beneficiary designation forms with the bank or the securities firm are not sufficiently detailed to carry out your wishes. 

At minimum, you should replace those forms with a custom form, called an “IRA Asset Will.”  Any attorney can inexpensively prepare this.  And if the custodian won’t accept it, move your account to another custodian that will.

As illustrated above, the changes in the IRA distribution rules didn’t change the need for proper distribution and inheritance planning.  A failure to understand the details could be very costly to you or your heirs.

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