How to Avoid a Common IRA Mistake
by Marissa Fitzpatrick
by Marissa Fitzpatrick
If you’re like many people, you’ve probably invested in an IRA for retirement. But one piece of advice I can give you is to always make sure one thing is in order: your beneficiary forms. Here’s why.
Many clients we encounter set up trusts to accomplish their personal goals, whether it be to avoid probate or protect assets from long-term care costs. These trusts contain other added benefits. Many of our clients will be able to add their trust as the beneficiary of IRA accounts (once meeting certain look-through requirements). Done correctly, it allows the IRA to pay out to a trust based on the life expectancy of the beneficiary of the trust. This sounds easy enough, unless the client changes advisors and forgets to update the IRA accordingly.
To show how this works, let me introduce you to our hypothetical clients, Jack and Jill. Jack and Jill each invested in an IRA. When Jack and Jill came to meet with us, they wanted to make sure their kids weren’t inheriting a large tax burden, so we set up multiple trusts as the beneficiaries of their IRAs. The purpose was to require their kids to stretch the IRA distributions over the course of their lifetimes. Mechanically, the IRAs would pay out to the trusts based on their oldest child’s life expectancy. These trusts ensured their children weren’t taking the lump-sum distributions and were saving on a large tax hit.
After executing their trusts, we notified the custodian of their accounts and had the trusts named as the beneficiaries. Everything was set to work according to their plan. One day, Jack and Jill decided to switch custodians and moved their IRAs to another advisor. Unfortunately, this advisor didn’t understand that Jack and Jill had created trusts specifically for their IRAs to pass through and didn’t correctly list the trusts as beneficiaries. Fortunately, we caught the mistake at our annual review meeting with Jack and Jill. Had the beneficiaries of the IRAs not been updated, Jack and Jill’s goals would likely not have been met.
This problem usually arises from not confirming that the new custodian completed the IRA beneficiary properly. The mistake that Jack and Jill almost made was solved by double-checking their beneficiary forms. This precaution will save their beneficiaries a lot of unforeseen taxes in the end, and it ensured their money will pass directly to their beneficiaries in a controlled manner.