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IRA Beneficiaries

Some days it seems that Murphy’s Law will help the IRS take what they never should in the first place. Two years ago, I wrote an article On my Death, Please, Take a Breath,  sharing the story of a man who inherited an IRA from his sister, and, being afraid of the stock market, cashed it out, creating a hefty tax bill, when minimum withdrawals would have kept him in the 10% bracket at most.

I’m reminded of this as I was answering a question elsewhere (are Elle and I the only readers of Usenet? Hmm).  A woman passed away and left an IRA worth $40K, but no designated beneficiary was listed on the account. This makes the IRA part of the probate estate which is subject to creditors. An IRA that has a proper beneficiary designation will pass to the beneficiary outside of probate and is typically not subject to any creditor obligations, except perhaps taxes due the IRS, especially estate tax. In this particular case, the deceased had obligations of $60K as an individual, so the value of the IRA was completely lost. In this case, there were no fancy tricks  required, no trusts, no expensive lawyers needed. The IRA custodian has a simple form that should be filled out when opening the IRA to avoid this potential loss.

With the end of the year coming up, now is a good time to check your retirement account beneficiaries. If you have any old accounts, it’s a good idea to double check that you set it up properly and fix it if you didn’t. If you are divorced, it’s possible your ex is still listed as beneficiary on an older account. It would be a shame if that were the case and when you pass, your current wife discovers it’s not her money. Perhaps (God forbid) a child has predeceased you, and he or she was listed as the beneficiary. All these situations point toward the need to simplify your finances. If you are retired, you can easily reduce your accounts to one IRA and one Roth IRA, and eliminate the need to chase the paperwork on multiple old 401(k)s or IRAs that were set up at different times.

Do you have a friend or loved one who made a similar mistake? I hope this article can help others avoid this type of costly error.

  • Elle December 1, 2011, 10:25 am

    Wow, great anecdote about IRAs not being subject to creditors, as long as a beneficiary who is alive is named. In this vein, anyone know off the top of their head the answer to the following? My will says nothing about my IRA. My IRA beneficiary is not the same as those named in my will to inherit my estate (such as it is). Is this a problem?

    (I not only read Usenet. I am also a big fan of the NY Times Letters to the Editor and NY Times comments sections. Unfiltered, and uncorrupted by the need to pay advertisers, I find reader comments often as or more helpful as the original article.)

  • JOE December 1, 2011, 5:12 pm

    Hi Elle!
    An IRA or 401(k) with properly named beneficiaries are not part of the probate estate. In other words, they pass to these beneficiaries regardless of the wording of a will. A beneficiary can go to Schwab (for example) with a death certificate and the deceased IRA accounts will be changed to ‘beneficiary’ accounts.
    Easy for someone to believe updating a will is all they needed to do, when marrying, divorcing, etc. The IRA beneficiaries need updating as well.

  • Marks@ Car Insurance December 2, 2011, 5:42 am

    IRA beneficiaries can also still choose distributions over the life expectancy of the IRA owner. The life expectancy table is used by finding the IRA owner’s age in the year of death and reducing that figure by one for each year after the year of death.

    Of course, the tax rules for an IRA beneficiary are a little different if the account owner dies before beginning distributions. In those cases, beneficiaries base required minimum distributions on their own life expectancies.

  • JOE December 2, 2011, 9:30 am

    Mark, agreed, but only if they are listed as the beneficiary on the account. The ‘stretch’ aspect of the IRA is broken if it passes through a will, and not through the proper beneficiary designation.

  • AverageJoe December 6, 2011, 8:21 pm

    On the man with the IRA in the first paragraph: It always kills me to see people exit an IRA when they’re afraid of financial markets. How hard is it to find out that you can go to cash INSIDE the IRA structure? …not that heading to cash is the world’s best answer….

    Checking beneficiaries is a great idea. …maybe an annual thing like changing the smoke detector battery.

  • JOE December 7, 2011, 12:48 am

    It’s a tough message, I guess. An IRA is not ‘an investment.’ It’s a tax designation, a wrapper for whatever investment (within the guidelines) you wish to have. If you fear the market, change the mix. But going to cash is a completely different decision than destroying the IRA. Thanks for commenting!

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