Updated: Aug 9, 2021
I had a nice couple, Moe and Deb from Charleston, come to my office recently for investment advice and estate planning.
Their questions concerned their investments, particularly their IRAs. They want to make sure that they are planning appropriately so that they can leave their wealth to the ones they love, their two kids, and they want to minimize any resulting tax consequences. At age 68 and 66, they are still relatively young, but they are smart to plan ahead.
As Ben Franklin said, "If you fail to plan, you are planning to fail."
When it comes to the financial aspect of estate planning, if you have an IRA, it is important to ask who will get it after you die. When I asked Moe and Deb that question, they seemed confused. They paused, looked at each other and responded, "Well, here, would you like to look at our will?"
Because that's where I would find the answer, right? Well . . . not necessarily.
Some of the most-costly estate planning mistakes I come across involve retirement accounts. Contrary to popular belief, the distribution of such accounts is typically not done pursuant to the terms of a will. Instead, the funds are almost always distributed to individuals named on beneficiary designation forms. Such forms are typically filled out when an account is opened, but should be amended as circumstances change. These forms notify the bank or financial institution (the IRA custodian) about who will inherit your accounts. Those named individuals are your beneficiaries.
Whether you are young or old, married or single, it's important to make sure all your beneficiary designations are in order and up to date.
If you opened the account years ago, check the designation on file, to make sure it reflects what your current wishes are. For example, if you or a family member got married or divorced; or have had children or grandchildren, you may want to make changes to your beneficiary designations.
Another small, and unexpected thing to note that some people are coming across is that, for decades, many beneficiary forms were held in paper copy in the World Trade Center buildings. Those forms obviously don't exist anymore, and people who had filled out their beneficiary forms prior to 2001, might want to check to make sure those forms are still viable and on record. There have been instances in recent years in which people were surprised to learn that their forms no longer exist, and it has cost them.
Anyway, back to my story, I reviewed Moe and Deb's current IRA with them. What we discovered is that somewhere along the line, they had never filled out the beneficiary form.
I explained to them that if you have an IRA, you should name primary and contingent beneficiaries. One of the great advantages of an IRA is that it does not need to pass through probate. It can pass directly to your named beneficiaries. However, if there's no beneficiary on file, guess what? Heirs are at the mercy of the IRA custodian's default policy. Most award an IRA first to a living spouse and then to the estate, but some send it straight to the estate.
If it is distributed to the estate, it must go through the probate process, which is very, very rarely a good thing.
I explained to Moe and Deb that another benefit of a properly executed beneficiary form is the ability to maximize the "stretch" rules allowed for IRAs. Generally speaking, an IRA beneficiary must withdraw a minimum amount each year and the first distribution must be taken by December 31 of the year after he or she inherits the account. If the beneficiary is an individual, and everything is done correctly, he or she can choose to "stretch" these minimum required distributions over his or her own expected life span.
Doing so can significantly reduce the required distribution because minimum required distributions are based on the beneficiary's life expectancy. Usually, a beneficiary is younger and therefore has a longer life expectancy than the life expectancy of the original owner. The longer the life expectancy, the smaller, as a percentage of the IRA balance, each payout must be. This strategy can significantly extend the tax advantages of an IRA. Stretching out the IRA gives the funds extra years and potentially decades of income tax-deferred growth in a traditional IRA or tax-free growth in a Roth IRA.
This is a wonderful tax planning opportunity.
On the other hand, if there are no named beneficiaries, and an estate "inherits" the IRA, the "stretch" provisions cannot be taken advantage of because the estate is not treated as an individual. Therefore, the funds must be distributed within five years of the death of the owner, if he or she dies before the Required Beginning Date (April 1st of the year following the year the owner turns 70 1/2); or, if the owner dies after the RBD, the distribution period is the deceased owner's remaining life expectancy calculated in the year of death.
Once again, the devil (or angel) is in the details when it comes to your financial plan, and small moves can have a big impact. When building your retirement system, you must make sure you seek out a retirement specialist who understands the whole picture.
This content created by Rick Durkee in conjunction with Fusion Capital Management.