Do you want your heirs to have to chase after your 401K or IRA money? It is important to make sure you have an up-to-date beneficiary form. On January 26, 2009, the United States Supreme Court unanimously ruled in the case of Kennedy vs. DuPont that the plan administrator was not required to honor a divorce decree. William and Liz Kennedy were married in 1971 while William was an employee of DuPont and a participant in its Savings and Investment Plan. William designated Liz as the sole beneficiary of his plan benefits. When William and Liz divorced in 1994, the divorce decree terminated any of her rights to William’s pension or retirement benefits. William never changed his beneficiary form. When William died in 2001, his estate demanded the plan funds based on the domestic relations order. The DuPont plan administrator refused and disbursed the funds to Liz, in reliance on William’s beneficiary form. The ex-wife, who was still listed on the beneficiary form, gets the money, even though the divorce court ordered her rights terminated and she signed a waiver.
It is important to understand that your will does not control who gets your 401K or IRA. The beneficiary form trumps your will. Filling out the beneficiary form correctly is critical. The biggest mistakes:
Mistake #1
The beneficiary form cannot be found. While the Supreme Court made it clear that the beneficiary form rules, if there is no form filed with the plan administrator, you are stuck with the default provisions of the plan. Often it will go to your estate, but this is not always the case. Make sure you can find the most recently filed form. Do not assume that the plan administrator will be able to find it either. With companies merging, going out of business, getting sold, or moving, files get lost or misplaced. The solution? Get an acknowledged copy of your beneficiary form from the plan administrator. Make sure that you keep the forms in a place that you and family can easily find. All of your planning goes out the window if the form cannot be found.
Mistake #2
The form is out of date. Have there been any changes in your life, such as marriage, birth of a child or grandchild, divorce, job change, retirement, a death? Remember that your will cannot change the beneficiary of your plan! It is imperative that you review the beneficiary form regularly. Another problem we see is accidental disinheritance of a child’s family. You name your three children as beneficiaries, intending each child to receive 1/3rd. Your oldest child predeceases you. At the time of your death your two surviving children receive 50% each instead of the 1/3rd you intended. Your oldest child’s family gets nothing. The solution? Review the form annually. Tax time is an ideal time since you are reviewing all of your financial records anyway.
Mistake #3
You have not named a backup beneficiary. If you do not name a back up beneficiary then any number of people could get the plan assets, or your estate. Each plan administrator has its own rules for this kind of situation. Example: you name your spouse as the only beneficiary. If your spouse dies before you, there is no beneficiary so your 401K or IRA may be liquidated, taxed and what is left will be distributed to your estate. It is a good idea to name someone, say your children, or a trust for your children, as the contingent beneficiaries. A single person may name his or her parents first and then a favorite charity as the backup beneficiary. Naming a charity as the primary or contingent beneficiary of your 401K or IRA is a great planning technique because the charity will pay no income tax upon receipt of the IRA funds.
Mistake #4
Naming a minor as a beneficiary. A minor cannot control funds, and a court appointed guardian will be in control. When the child turns 21 (18 in some states), the child will have unfettered access to the funds. The solution? Set up a trust so the funds are managed under your instructions, and by people of your choice.
Mistake #5
Missing out on the stretch IRA opportunity. The stretch IRA is set up through your beneficiary form. Stretching the IRA payments over the lifetime of the beneficiary allows the IRA to grow tax deferred while making relatively modest annual distributions. But, IRS statistics show that 90% of IRAs are cashed out within 6 months of death. The solution? Again, a trust can be put in place to make sure that the funds will be used over a lifetime instead of immediately withdrawn.
Mistake #6
Not providing creditor protection for the beneficiary. Would you like to protect your child’s inheritance from divorce, lawsuits, creditors, business failure, or even bankruptcy? Some children suffer from poor money management skills and others have special needs. Assets retained in IRAs are much safer for these purposes than assets held outright. A trust can be used to restrict assets held in a stretch IRA.
The bottom line: Done correctly your 401K or IRA can preserve some significant funds for future generations to enjoy. The rules surrounding retirement plans and IRAs are complicated enough, but don’t compound the difficulty by not paying attention to your beneficiary forms. When a good portion of your assets consist of a retirement plan you need expert help.
