Some IRA planning and investment strategies may appear easy to execute, but errors can lead to unexpected taxes or penalties, loss of the IRA’s tax-exempt status, and even disinherited beneficiaries. Many of these situations involve incorrect or outdated beneficiary designations.
Failing to update beneficiaries when circumstances change
For example, if you’re married, you probably named your spouse as the primary beneficiary. But what happens if you get divorced and fail to update the beneficiary to either your children or your new spouse (if you remarried)?
If you pass on before making these changes, your ex-spouse could legally take ownership of your IRA, causing legal headaches for those you really wanted to inherit these assets.
Naming your estate as a primary beneficiary
Naming your estate as the primary beneficiary is a common choice as well. This may seem prudent, as the intention is to let the will or trust document decide how assets will be distributed, but it can be a costly mistake.
An estate IRA beneficiary has no age or life expectancy, which leads to fewer distribution options. For example, estates are generally required to distribute all funds within five years. Under this scenario, an estate that is a primary IRA beneficiary would have to distribute assets in the IRA to the named heirs within five years. This could result in larger distributions and potentially higher taxes.
However, if the decedent's spouse or children are IRA beneficiaries, the distribution period could be much longer. For surviving spouses or chronically ill or disabled children, assets may be gradually distributed over the course of their lifetime. Children who inherit IRAs have ten years to fully deplete the account.
Creditor protection is something else to consider. Generally, leaving assets to a named beneficiary offers protection from creditors. With assets left to the estate, however, the probate court would include the estate in the decedent’s total assets, opening the door to creditors’ claims.
Forgetting about your other retirement account beneficiaries
Whatever beneficiary “corrections” you make to your IRA you should also consider making to any 401(k), 403(b), 457 or other retirement plan accounts with your current or former employers.
Get into the habit of annual beneficiary reviews
Now that you know the risks of making the wrong legacy planning decisions, make it a habit to review the beneficiaries for all of your retirement accounts at least once a year, and whenever you undergo a major life event, like a divorce or the death of a spouse or child.
If you need help making these decisions, speak to a financial advisor or your estate planning attorney.
Joelle Spear is a financial advisor and Partner located at Canby Financial Advisors, 161 Worcester Road, Framingham, MA 01701. She offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. She can be reached at 508.598.1082 or firstname.lastname@example.org
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