By: Kathy A. Brost, Trust and Financial Advisor, Legacy Private Trust Company
I always recommend that you name at least two beneficiaries for your accounts, and it’s particularly important for IRAs and retirement plans. Generally, IRA owners assume they can name their children or another contingent beneficiary at a later date if something happens to their spouse, but that is not always the case. Here are 10 reasons why you should always name at least two beneficiaries on your retirement accounts:
1. You will help your heirs minimize income taxes the same way you did. For many, their IRA and retirement accounts are some of their largest assets. If you work hard to maximize your contributions (and minimize your income taxes) through your retirement plan or IRA, you will also give your named heirs the ability to minimize income tax on those assets when they are eventually distributed.
2. Spreading IRA distributions over the beneficiary’s lifetime saves money. It makes a significant difference in the income tax rate, the income taxes paid, and the remaining after-tax amount that your heirs eventually receive from your IRA. However, if a beneficiary is not designated on the IRA itself, the entire IRA may have to be distributed within a year or two after the owner’s death, and IRA distributions are taxed as ordinary income. Also, your IRA’s eventual beneficiaries may not be able to rollover or transfer the distribution from your IRA into another IRA unless they are listed on the beneficiary designation. The same rules apply for retirement plans like 401k and 403b accounts.
3. If you become incapacitated over time, you may lose the ability to add another beneficiary at a later date. Financial power of attorney documents generally do not, and should not, allow for another person to name a beneficiary for you on your IRA or retirement plan. This can become a problem as a person ages and may begin to experience cognitive decline.
4. Incapacity can be sudden and irrevocable, as in cases of health emergencies or accidents. In cases like these, you may not recover sufficiently to be competent enough to designate an additional
5. You and your primary beneficiary may be involved in a common accident. This would be another time when you may not be able to add another beneficiary.
6. You might inadvertently cause a costly administrative problem or family conflict after your death. Unless you review your beneficiary designations annually and upon all major life events, you may forget to update your beneficiary designation. A contingency beneficiary ensures your funds stay with a person of your choosing if the primary beneficiary is no longer alive.
7. A listed contingent beneficiary allows your primary beneficiary to disclaim all or a portion of his or her share of your IRA to the contingent beneficiary. Your contingent beneficiary would be able to spread out the distributions and taxation from your IRA over his or her lifetime.
8. Beneficiary designations take precedent over your will for your IRA and retirement plans. Listing your heirs in your will is not an effective way to designate people as beneficiaries of your retirement accounts. Your IRA may end up being distributed to your estate and your estate may end up paying income tax on the IRA distribution with just the after-tax proceeds being paid out to your children. The after-tax proceeds could be almost half of your IRA or retirement plan balance!
9. You can take the opportunity also, to arrange for a trust or a Uniform Transfers to Minors (UTMA) if one or more of your beneficiaries are minors.
10. It’s simple and easy to do. Generally, you must use the financial institution’s beneficiary designation form and send the signed form to the financial organization for the designation to be effective.
Please note, designating two primary beneficiaries can work the same as having a contingent beneficiary. Remember to read the terms of the beneficiary designation to make sure that your designations will distribute your IRA or retirement funds in the manner you desire.