Some people assume that because they’ve named a specific heir as the beneficiary of their IRA in their will or trust that there’s no need to list the same person again as beneficiary in their IRA paperwork. Because of this, they often leave the IRA beneficiary form blank or list “my estate” as the beneficiary.
But this is a major mistake—and one that can lead to serious complications and expense.
IRAs aren’t like other estate assets
First off, your IRA is treated differently than other assets, such as a car or house, in that the person you name on your IRA’s beneficiary form is the one who will inherit the account’s funds, even if a different person is named in your will or in a trust. Your IRA beneficiary designation controls who gets the funds, no matter what you may indicate elsewhere.
Given this, you must ensure your IRA’s beneficiary designation form is up to date and lists either the name of the person you want to inherit your IRA, or the name of the trustee of your trust, if you want it to go to a revocable living trust or special IRA trust you’ve prepared.
Moreover, not naming a beneficiary, or naming your “estate” in the IRA’s beneficiary designation form, means your IRA account will be subject to the court process called probate. Probate costs unnecessary time and money and guarantees your family will get stuck in court.
When you name your desired heir on the IRA beneficiary form, those funds will be available almost immediately to the named beneficiary following your death. But if your beneficiary has to go through probate to claim the funds, he or she might have to wait months, or even years, for probate to be finalized.
Plus, your heir may also be on the hook for attorney and executor fees, as well as potential liabilities from creditor claims, associated with probate, thereby reducing the IRA’s total value.
Reduced growth and tax savings
Another big problem caused by naming your estate in the IRA beneficiary designation or forgetting to name anyone at all is that your heir will lose out on an important opportunity for tax savings and growth of the funds. This is because the IRS calculates how the IRA’s funds will be dispersed and taxed based on the owner’s life expectancy. Since your estate is not a human, it’s ineligible for a valuable tax-savings option that would be available had you named the appropriate beneficiary.
Typically, when an individual is named as the IRA’s beneficiary, he or she can choose to take only the required minimum distributions over the course of his or her life expectancy or a period of 10 years depending on the relationship to the original owner of the IRA. Stretching out the payments in this way allows for much more tax-deferred growth of the IRA’s invested funds.
However, if the IRA’s beneficiary designation lists “my estate” or is left blank, the option to stretch out payments is no longer available.
This means the beneficiary who eventually gets your IRA funds from your estate will have to take the funds sooner—and pay the deferred taxes upon distribution. This limits their opportunity for additional tax-deferred growth of the account and requires him or her to pay a potentially hefty income tax bill.
A simple fix
Fortunately, preventing these complications is super easy — just be sure to name your chosen heir as beneficiary in your IRA paperwork (along with a couple alternate beneficiaries). And remember to update the named beneficiary if your life circumstances change, such as after a death or divorce.
At the Law Office of Keoni Souza, we can help you select the ideal beneficiary for your IRA and other estate assets. What’s more, we have systems in place that will ensure your designated beneficiary form is always up-to-date with the correct heir listed should your life circumstances dictate a change. Contact us today to get started. This article is a service of the Law Office of Keoni Souza, LLC, an estate planning law firm in Honolulu, Hawaii. We don’t just draft documents; we ensure you make informed and empowered decisions about life and death, for yourself and the people you love. That's why we offer a Family Wealth Planning Session, ™ during which you will get more financially organized than you’ve ever been before, and make all the best choices for the people you love. You can begin by contacting our office today to schedule a Family Wealth Planning Session and mention this article to find out how to get this $750 session at no charge.
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