By FPA member Rick Fingerman, CFP®
Last Updated: March 19, 2012
Did you know that a beneficiary designation supersedes one’s wishes in their Will?
Let’s say Mary has an Individual Retirement Account (IRA) and years ago, named her husband Pablo as the primary beneficiary. They have now been divorced for many years. According to Mary’s Will, everything will be left to her sister, Monica. If Mary were to pass away, Monica will NOT receive the IRA assets and they will go to Pablo. This is probably not what Mary would want.
It is important to review your beneficiary designations as many people may think their assets are going to one person when in fact, they may not be.
People’s lives change as well as the people in them. Sometimes a spouse or partner passes away and their name is never replaced. One may get divorced and forget to remove their ex-spouse’s name and replace that with another. You might have a falling out with a sibling or have a child that shouldn’t inherit money due to an addiction issue.
Some people simply fail to name a beneficiary in the first place or they name their estate. By naming one’s estate as the beneficiary, one may be giving up some unique tax strategies as well as control.
When one names an individual as beneficiary of their IRA, it allows the beneficiary to receive this money over their entire life. Conversely, if they took it all out at once, the entire balance would be taxable. By taking it out over their life, they only pay tax on the amount withdrawn from the account while the balance remains tax deferred. Bear in mind that these rules apply to traditional IRA’s and not Roth IRA’s. There are also special considerations when a spouse inherits an IRA vs. a non-spouse. There are even different rules if a spouse is more than 10 years younger or if an IRA owner dies before age 70 ½ or after taking distributions.
What if you named your estate as beneficiary on your IRA? Is there a way for your kids to inherit this money and still take it out over their lives? Yes and no. If your Will leaves your IRA to your kids, they could divide the account up for each of them. However, the IRS says they must take the money based on their mom’s life expectancy and not their own. Since their mom is older, the amount taken out each year will be higher than if they were named as beneficiary. Therefore, more tax will be due and the account wouldn’t potentially last as long.
One’s life insurance, annuity, transfer on death (TOD), or payable on death (POD) account may not offer the same tax strategies as one’s IRA however. These should also be checked as the wrong beneficiary could be named.
Since these rules can be complex, it is always best to seek the advice of tax, legal and financial planning professionals before making any decisions.
FPA member Rick Fingerman, CFP®, is Founder and President of Financial Planning Solutions, Inc. in Newton, Mass. Rick is a past president of the FPA of Massachusetts and currently holds the position of Liaison for the Dana Farber Cancer Institute Pro Bono Financial Coaching Program. Rick has been quoted in national publications, including The Wall Street Journal, Boston Globe and the Chicago Tribune.