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It was a horror story—a man planning for the future of his grown children before losing his life to cancer, only to have the $400,000 in his IRA go to his wife of two months, who cut the children out the wishes of his will. Leonard Smith had thought it would be a straight-forward transaction. After he died in 2008, it was a full year before his children had realized that they had been ruled ineligible to receive his retirement funds, and Smith’s wife – who, by default, got all of it – had no intention of giving it to them.
One mistake was to blame: Rather than naming each child beneficiary of the account, along with how he wanted the funds portioned, Smith wrote “To be distributed pursuant to my last will and testament.” This one line invalidated the document, and the wife received all of the money according to state law. By default, if specific instructions are not spelled out on the IRA Beneficiary Form, the money goes to an individual’s estate and if married may go to the spouse. It took a full year for Smith’s children to realize what had gone wrong. They took Smith’s widow to court and lost.
While the last will and testament is a legal and binding document, it typically does not overrule an IRA Beneficiary Form in regards to possession of retirement funds. It didn’t seem to matter to the court that Smith’s intention was for his children to receive the money. It followed the Beneficiary Designation Form which had language he did not realized what the ramifications were.
“I had no idea that a will could be trumped by an IRA Beneficiary Form,” Smith’s daughter Deborah Smith-Marez, 50, told Yahoo Finance.
Estates are governed separately from accounts with beneficiary designations, such as IRAs which are trusts valid under state law. By naming a beneficiary, by operation of law the assets left by the deceased would go to the named beneficiary(ies) without going through probate. This is why it’s so important to always have these beneficiary forms current. After every major life event, update these forms. If no major event, such as the birth of a child or grandchild, a death of a beneficiary, marriage, or divorce occurs, take the time to review your selections. It’s best to do so on a regular basis.
Here are a few more tips to ensure that the people you choose to receive your retirement funds get the money in the event of your death.
Find an advisor or planner licensed to practice in your state.
- Mistakes can happen more frequently if you decide to manage the documents yourself or use the help of someone not familiar with applicable laws.
Beneficiary forms:
- It’s important to make sure you have the most-up-to-date version of the form. Ask the financial institution to provide a copy of the most recent version. If the IRA administrator merges with another company or changes its name, fill out a new form. It’s better to be safe than sorry. Beneficiary forms may be amended by the IRA holder at anytime.
- If you fill out an online beneficiary form, print out several copies for your records, as well as that of your estate planner or financial advisor. Since most financial custodians don’t send out automatically Beneficiary Designation Forms for you to update, create a reminder in your calendar to make you review the forms in a frequency you feel comfortable with. This will save your family from a lot of heartache later.
- Tell your family or heirs where you keep your important documents, so they will be easy to find.
Spouse vs. “non-spouse”
For tax purposes, IRA beneficiaries besides the spouse are one or the other. A non-spouse can be a family member or unrelated person. A non-individual may be a trust, charity or other entity. Only a spouse can transfer or conduct a tax-free rollover of the original IRA into his or her own IRA. If given to a non-spouse, the IRA gets a “second life” and the beneficiary is allowed to deplete the account incrementally based on the beneficiary’s life expectancy. Additionally, the beneficiary may accelerate distributions above the required amount without penalty. Non-spouse beneficiaries may transfer their accounts to another financial institution as long as the receiving financial institution has no restrictions in receiving the transfer. If transferred, the account will remain an inherited account which carries the distribution elections with it to the new institution. A charity, meanwhile, will get the reported proceeds without having to pay any taxes, since approved charities are exempt from taxation.
To avoid creating unnecessary stress and legal disputes, it is important to have beneficiary forms correctly completed and filed. If you own an Entrust IRA and would like to make any updates to your account, you can download our Beneficiary Designation Form from our forms page.
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