The Importance of Updating Retirement Account Beneficiaries

Have you checked who you've designated to inherit your retirement account recently? If not, you may find that your designated beneficiary is not who or what you think it should be.

If you have divorced and remarried, your ex-spouse may still be on the form. If you named a charity as your beneficiary a long time ago, the charity might no longer exist. And what if your primary beneficiary has predeceased you? While many of us ensure that other important documents such as wills are updated on a regular basis, we tend to forget the designations on our individual retirement (IRA) and 401(k) accounts.

They're easy to overlook. After all, you filled in a name when you established the account ages ago and have had no need to look at the registration paperwork since. But to ensure your wishes are followed after you go—and to save your survivors the trauma and expense of a legal fight—check those designations periodically and keep the beneficiaries current.

Changing Outdated Beneficiary Designations

How do retirement account designations get overlooked? Sometimes it's just life—after all, if you've just had your second child, your first thought probably isn't going to be, "I've got to add her to the IRA beneficiary list; otherwise, her big brother will inherit it all."

Also, people often don't realize that retirement account designations are their own separate thing. State laws vary, but, generally speaking, these accounts are not governed by provisions in your will or a trust (unless you name the trust the beneficiary).

Many court battles have ensued because a person's will might say, "I'd like my IRA to be divided equally among my three children," but only one of those children is actually named as a beneficiary in the IRA records. Usually, in the eyes of the account custodian (the brokerage or bank maintaining the account) and often the law as well, the designation of the IRA trumps any other directive.

To prevent these situations, you should update your beneficiary designation immediately after you experience a change in family status and review it periodically, so it never becomes outdated or incorrect.

Fortunately, changing your beneficiary isn't hard to do. You may revoke your existing beneficiary and designate a new beneficiary by submitting a change-of-beneficiary form. You can add additional beneficiaries the same way. You can also draft customized beneficiary designations to address "what-if" situations.

Request a confirmation of receipt of the designation from your retirement account trustee, custodian, or an administrator. Documents do not always reach their intended recipients. Beneficiary designations are considered in effect only if they are received by the responsible party (e.g., trustee, custodian, or administrator) before the account owner dies.

Default Beneficiaries

Custodians don't let it happen so much nowadays, but it's possible you left your beneficiary designation blank when you established the account. If you fail to document your beneficiary designation, your beneficiary may be determined by federal or state law or by the plan document that governs your retirement accounts.

For qualified plans, such as profit-sharing plans, 401(k)s, and money purchase pension plans, federal regulations automatically designate the spouse of the account owner as the beneficiary. No one else may be designated as the primary beneficiary unless the spouse signs a document approving the designation and has it notarized. If the retirement account owner is not married, the estate may be the default beneficiary.

State law determines the treatment of IRAs. Some states, known as community or marital property states, require written spousal consent if the IRA owner designates anyone other than, or in addition to, a spouse.

The following states require the consent to be notarized:

• Arizona
• California
• Idaho
• Louisiana
• Nevada
• New Mexico
• Texas
• Washington
• Wisconsin

In other states, the default provision of the IRA plan determines the beneficiary if one is not designated by the plan holder.

An IRA plan's documents also default the designation if the designated beneficiary predeceases the IRA owner. The default options vary among IRA custodians and trustees.

While the default options remove administrative responsibilities from account owners, they may not reflect their preferences. This is why account owners should check the plan document and be sure they update their beneficiary designations frequently.

Many spouses, expecting that one will predecease the other, name each other as their designated beneficiaries. But what if, tragically, both die at the same time—in a plane crash, for example?

The issue of simultaneous death is addressed by state law, which will determine that one spouse died first. This determination is critical because it dictates whose will or directives govern the subsequent bequests.

Again, proper account documentation designating successor beneficiaries for normal and extenuating circumstances will keep this kind of situation from arising.

Consider a Customized Designation

Most IRA plan documents provide default beneficiary options. For instance, if you name two individuals as your designated beneficiaries and one predeceases you, the share that belonged to the deceased beneficiary automatically goes to the surviving beneficiary.

With a customized designation, you can choose how that portion would be distributed instead of having it default to the surviving beneficiary. For example, if one of your beneficiaries has children, you can designate those children to receive the primary beneficiary's share if they pass before you.

When drafting your customized beneficiary designations, you can explore various options to determine the one that meets your needs. The beneficiary designation you choose may determine if your elections are carried over to the next generation.

The following are some basic beneficiary designation designs:

Per Stirpes Designation

In the event your primary beneficiary predeceases you, a per stirpes beneficiary designation provides that the share that person would have received goes to their heirs.

For instance, assume you name your two children, Mary and John, as your primary beneficiaries. Mary's share is 80% of the assets, while John's share is 20%. Should Mary predecease you, her share would go to her heirs upon your death.

Per Capita Designation

A per capita beneficiary designation also provides that your primary beneficiary's share goes to that person's heirs. However, the allocations are not handled in the same manner as under the per stirpes designation. Should your primary beneficiary predecease you, their share would be divided equally among your successor heirs.

For instance, assume Mary and John (from the previous example) both predecease you. The assets will be allocated among their children equally, even though the beneficiary designation provides Mary with a larger portion of the assets.

If Mary and John each had two children, each child would receive a 25% share. (By contrast, under the per stirpes formula, Mary's children would divide 80% of your IRA, each getting 40% of it. John's children would divide 20%, getting 10% each.)

Trust Beneficiaries

If you feel you need to retain some degree of control over the disposition of the retirement assets after your death, you may consider designating a trust as your beneficiary.

There are various trust options to choose from, including qualified terminable interest property (QTIP) and qualified domestic trust (QDOT).

Designating the right type of trust as your beneficiary can allow you to provide financial support for both your surviving spouse and children from a previous marriage.

To ensure the spouse has enough to last a lifetime, some trust provisions restrict the surviving spouse's access to the assets. This can come in handy for beneficiaries who may not be financially sophisticated.

Trusts are complex and require expert assistance to establish to make sure they don't cause adverse tax consequences. Be sure to seek competent counsel from a trust and estates lawyer before you make any decisions regarding customized or trust beneficiary designations.