Don't err in designating your heirs
(Article appeared in Special Edition of Kiplinger's Retirement Report, Summer 2007)
This is a test. Can you recall who you named as your primary and secondary beneficiaries on your IRA? How about your life-insurance policy, annuity, half-dozen brokerage accounts and 401(k)? And if you can't remember, you can still find the forms, right?
You may have put a great deal of thought into providing for your heirs in your will. But the assorted contracts pass to beneficiaries outside your will.
You can easily wreck your overall strategy, and your heirs could lose some tax benefits, if those designations were not carefully considered. "It's worthwhile to integrate the beneficiary designations with the rest of the estate plan so that they reflect your estate-planning goals," says Lawrence Richman, chair of the private wealth services group at the law firm of Neal, Gerber & Eisenberg, in Chicago.
The first thing you should do is gather the documents for review. You'll need to consider both your primary beneficiary as well as the contingent beneficiaries, who will get your assets if the primary beneficiary dies before you do. "In many cases, clients need to make changes because the designations no longer fit their wishes," says Jeffrey Marshall, a lawyer with Marshall & Associates, in Williamsport, Pa.
Marshall recalls several cases where custodians have lost designations after several iterations of bank mergers and acquisitions. If you don't have copies and your account custodians have lost them, make sure you update them with a formal letter to the trustee, custodian or administrator. But check with your estate-planning lawyer because there could be tax implications depending on who you designate.
As you review your documents, there are some other considerations to keep in mind.
Protect your kids' kids. Let's say you have named your two sons and daughter as equal-share beneficiaries of your IRA. But if your daughter predeceases you, what happens to her share? It could depend on the default provisions in your plan. If you want your daughter's share to go to her children, make sure your lawyer drafts instructions that the distribution should be made by line of descent. Otherwise, her share might be split between your two sons.
If you've remarried, your beneficiaries of your life insurance could be your new spouse and your two children from your first marriage. But if the default provision calls for the line-of-descent distribution, the new spouse's kids will get one-third of the proceeds if your new spouse dies before you. If that's not your intention, leave written instructions to split the policy among your named beneficiaries.
Avoid naming your estate. If you designate your estate as the beneficiary of your IRA, your heirs won't be able to stretch out the tax-deferred growth in the account over their lifetimes. If you leave the IRA to your estate and die before age 701/2, when you would have been required to take minimum distributions, the rules force your heirs to cash out within five years. By naming real people, your heirs can make minimum withdrawals based on their life expectancies.
Be charitable. If you intend to leave part of your estate to charity, naming a charity as the recipient for at least part of your IRA could actually be a good tax move for your other heirs, says Richman. It does not matter to the tax-exempt organization whether the money comes from your IRA or from your taxable accounts. But money in a taxable account passes tax-free to your heirs, while IRA money is taxed in the heirs' top brackets when they withdraw it.
However, if you plan to name a charity and other heirs as beneficiaries, it's essential that they take one of two actions before September 30 of the year after your death. Either they must see that the charity cashes out its share or they should split the account into separate IRAs. If they miss the deadline, the assets in the inherited IRA will have to be distributed within five years after you die. Your heirs would lose the chance to stretch payouts over their lifetimes.