Beneficiary Mistakes — Self-Directed 401(k) or IRA (Part 2)

In the previous post, we introduced three potential beneficiary designation mistakes.  In this post, we will point out a few more.

Don’t Name Your Kid!

This is not meant as harsh as it sounds.  As with other considerations, this relates to the issue of age.  There are WAAAAY too many people who identify their minor children as either a primary or secondary (contingent) beneficiary.  Well, guess what?  Do you think if you pass away (or both you and your spouse pass at the same time if your spouse is the primary beneficiary), the courts are going to let your 10 year old (example) directly receive your IRA or 401(k) benefits?  Of course they won’t.

You will want to strongly consider naming a guardian for such potential circumstances.  If you don’t, and the worst happens (you passing), the court will appoint a guardian and, drum roll please, this guardian may not be who you would have wanted it to be.

Want to Truly Benefit Your Beneficiary (maybe life insurance)

Please note that this is not a mistake issue, but a pro-active consideration that most do not consider, and should. What exactly are we speaking of?  In most cases, any time you leave pre-tax funds from an IRA or 401(k) plan to your beneficiaries, there will still be taxes due.  The IRS is always going to “get theirs”, right?!

How does life insurance enter into this picture?  If you are one of the fortunate individuals who can afford the premiums and want to benefit your children in the best way, purchasing a life insurance policy with your heirs listed as the beneficiary may be of interest. Again, assuming your children are of adult age, any life insurance proceeds will go to your beneficiaries tax free. Whereas, the receipt of pre-taxed retirement plan funds will be taxed.  For those so inclined to consider this strategy, it may be a much better strategy to gift rather than leaving pre-tax retirement funds to your heirs.

Beneficiary Form is AWOL

Just like the proverbial soldier who goes AWOL, you may have completed your beneficiary designation form, placed it in your favorite hiding spot for safekeeping….you think you are all done.  But, what happens if you don’t let your primary beneficiary or interested party (e.g., trusted family member, attorney, CPA) know where it is?  Or provide them a copy?  Better yet, why wouldn’t you keep it in a home vault or bank safety deposit box…and, let them know where it is?!

Bottom line:  unlike a game of hide and seek where you don’t want to be found, you want the beneficiary designation form to be found.  You are not trying to hide this important information from your beneficiary.  It is important for your beneficiaries to know where you left it and how to access it.  Sometimes people think of the beneficiary form as a private matter….and, it is….but, your designated beneficiaries must know about it and where it is.

Also, let’s go back to the first blog where we spoke of your IRA beneficiary form being completed through the IRA custodian.  Don’t simply rely on this and assume that it is in total safe-keeping.  Should it be…of course.  However, there have been many circumstances where a custodian lost, misplaced or cannot present beneficiary forms at the time of death.  While this should not ever occur, it can.  Why not safeguard yourself by keeping a copy of this designation form in a safe spot….just as a backup.

Finally, maybe the biggest mistake one can make with their IRA or 401(k) beneficiary designation form is:

Identifying Your Estate as Primary/Sole Beneficiary

Far too many people incorrectly believe that the beneficiary designation form is not critical as they think, “Ah, that will just to go my estate.”  Or they may think, “I am going to use all of this money to live on and there will be nothing left to leave a beneficiary, anyway.”

Again, the beneficiary form is very important.  By not naming a beneficiary or purposely electing their estate as the beneficiary, they have hurt their beneficiaries in their ability to maximize account growth.  If the beneficiary is the estate, it prevents an intended non-spouse beneficiary (e.g., children) from maximum growth potential and, instead, speeds up maximum taxation.  This is a potential travesty as the intended beneficiary will have immediate (5 years) accelerated taxation schedule, and prevents the beneficiary from stretching out the taxes due over their lifetime.

It ain’t over til its over…finally, consider these two sobering facts:

Without a properly executed beneficiary form, retirement plan funds revert to your estate and are subject to potential claims of creditors.  Further, any distributed funds from the probate process would not be paid until that process concludes….which can take up to a year, or longer.

As always, the information provided is intended to be educational in nature.  It is not intended, nor should it be interpreted as, any form of tax, legal, financial or investments advice.  You must always consult with your respective professional in all such matters.