Beneficiary Mistakes — Self-Directed 401(k) or IRA (Part 1)

This post is for beneficiary mistakes within an IRA or 401(k)….self-directed or not.

Potential beneficiary mistakes with your self-directed 401(k) or IRA can be very real issues.  With proper planning and maintenance, your beneficiary can greatly benefit from your gift.  With poor planning, it can turn into a curse. As part of proper planning, you should always review your beneficiary strategies with your legal professional; however, some of these beneficiary mistakes are mistakes that many people make…and, don’t need to.  And, don’t be fooled into thinking that these type of mistakes can’t happen to you….many happen each year with countless number of individuals.

As evidence of how “life happens”, I had a client who passed away this year.  She was a real sweetheart who was diagnosed with terminal cancer.  She was living life without a care in the world.  She started feeling sick, it got worse and, by the time she was diagnosed, she had little time left.  She literally passed away in three weeks from the time of initial diagnosis.

Her intended beneficiary was reeling from her passing but also had to start getting some of her affairs in order.  On top of the pain he was experiencing from his loss, got compounded when he found out that she had never completed a beneficiary designation form for her 401(k).   We all get it. She was relatively young, otherwise healthy, and then…bam!  I am sure that she never imagined her life would turn upside down in literally a month.  I mean, who would.    But the mere fact that she did not execute the 401(k) beneficiary form created unforeseen and unfortunate circumstances for her intended beneficiary.

So, what are some potential mistakes that you may want to keep in mind regarding your IRA or 401(k).

Actually Completing Your Beneficiary Form

This falls under most people’s category of “Duh.”  I mean all IRA and 401(k) retirement plan holders are provided this form, yet you would be amazed how many people do not even complete it.  This can be especially true with a Solo 401(k) plan where someone isn’t forcing you to complete it.  You are the Trustee and no one else, so it all falls upon your shoulders.

And, if you say it can’t happen, well read above again.  This was a lady who was an engineer and extremely focused and, yet, she never completed the form

Okay, for those of you who have IRAs you may ask the question, “didn’t I complete a beneficiary form when I first set up my self-directed IRA?”  And, the answer would be “yes”.  But, stay tuned to the next issue.

“Life Issues” Got the Best of You

It happens to all of us….life happens.  Death, divorce, the list can go on.  Bottom line, life changes and so may the need for you to update your beneficiary form.  Has it ever occurred that an individual got divorced, re-married and, possibly, had a second family, while at the same time never amending their original beneficiary form(s)?  Uh, yes. And, in many of these cases the original instructions of the designated beneficiary were legally honored.  Are there that many people, prior to death, who would have said that they wanted their retirement assets going to an ex-spouse…..probably not.

And, if that is not bad enough, what about the situation where your beneficiary passes and you never removed them as the beneficiary of any of your retirement plans?  Now, that is not pleasant to think of.  What a hornet’s nest.

With regard to these first two items, one would take the sage advice to put on your calendar to review your beneficiary forms at least annually, and certainly after any potentially major life event.  Most individuals may even believe that such a review is not necessary as they have a will.  The ole “I have a will…that will take care of everything.”  But, few realize that a properly completed beneficiary form will take precedence over your will.  So, make sure you pay attention to the simple completion of your beneficiary designation form.

 Losing Control Over Your True Wishes

After your initial concern in benefiting your spouse, the next logical step of protection and gifting for most people is to name their children as beneficiaries.  But, naming your children with no restrictions on when and how they receive the gift?  Hmmm, could be interesting!  Gifts from parents are usually to benefit their children and their families vs. gifting your child just so they can go purchase a new hot rod car, or taking a drinking binge trip around the world.  You can fill in whatever ghastly way the money could be spent in which you would not approve.

More than anything, this potential concern will rest more upon your child’s age and maturity level.  If they are older and more mature, this may not be as much of a concern.  If they are younger and filled with testosterone or estrogen….maybe a bigger concern.  The point is if you have a concern over this issue, you can set limitations on how the gift is received and spent.

What to do?  Well, first of all, discuss your interests and/or concerns with a competent legal representative.  You may want to establish a Trust that will honor your wishes after your passing.  Want to limit how much your beneficiary can receive and how often?  You can.  Want to permit the receipt of such benefits to “necessary” or “life promoting” areas of interest such as: down payment on a residence, health-related expenses, educational expenses, etc.  Again, you can.  Want to prevent the beneficiary receiving funds for any reason THEY want?  You can.  You can also establish the Trust to pay interest only if you are interested in preserving the capital.

Should you establish a Trust?  You know what I am going to say….it is up to you.  Trust formation and administration can be expensive for many.  But, it is certainly a viable option and you should know it is available to you in protecting your interests and your heirs (beneficiaries).

In the second part of this series, we will look at a few more mistakes that can occur.  Remember, as always, this information is intended to be educational in nature.  It is not intended, nor should it be interpreted as, any form of tax, legal, financial or investment advice.  You must always consult with your respective professional in all such matters.