When most people hear the phrase "estate planning," they immediately think of a will. However, while a will is often the cornerstone of an estate plan, there are certain types of assets it does not control, including insurance policies, individual retirement accounts, 401(k)s, and similar retirement accounts. These assets can be worth huge sums of money, and if you want to make sure they pass to your loved ones with no problems when you die, you'll need to take some extra steps beyond writing a will.
Many people fail to regularly review these accounts and policies to make sure these assets will pass to the right beneficiaries. That's why there are so many stories about retirement savings and insurance policies going to the deceased's ex-spouse, rather than their new spouse. Despite the obvious unfairness of such outcomes, the courts have consistently held that the terms of the beneficiary form associated with the asset determine who ultimately receives the account.
Due to the ongoing mergers and acquisitions of banks and brokerage firms, these financial institutions often claim they're unable to locate the original beneficiary forms for the retirement accounts of some clients. As a result, they may attempt to force an account's default provisions on the account owner, and the results may defy the account owner's wishes and produce adverse tax consequences.
This is a common issue with individual retirement accounts (IRAs). Many banks and brokerage firms require IRA account owners to use their estate as the default beneficiary on their IRA account. As a result, their beneficiaries lose the opportunity to maximize tax-deferral through the use of the so-called "stretch" provision. The "stretch" provision simply allows the beneficiary -- or possibly multiple beneficiaries -- of a retirement account to "stretch" the required distributions from the account over their own lifetimes, rather than the much shorter distribution period legally required when an estate is the beneficiary of the retirement account.
To ensure that your wishes are honored with regard to retirement accounts and insurance policies and to avoid adverse tax consequences, you should consider doing the following:
- Contact the financial institution or insurance company associated with the account or policy and ask it to confirm, in writing, that it has the beneficiary form covering the account or policy. Ask the company to send you a copy of the beneficiary form it has on file. If the financial institution is unable to provide a copy of the account's beneficiary form, then complete a new form and ask for the documentation previously discussed.
- Review all beneficiary forms for such accounts and policies to ensure they still reflect your wishes with regard to the disposition of the asset. This review should be done on a regular basis -- for instance, every other year -- and immediately after a major life event such as a divorce, remarriage, death, birth, or adoption.
- Review all beneficiary forms for such accounts and policies to ensure that beneficiaries are prepared to take advantage of all available tax benefits and avoid unnecessary taxes.
One of the most common mistakes retirement account owners make is designating their estate as the beneficiary of the account. While quick and easy, designating one's estate as the beneficiary of a retirement account automatically results in the loss of the stretch option for the account. Owners of retirement accounts should consider consulting someone experienced in setting up retirement accounts and beneficiary forms properly, such as an attorney, a certified public accountant, or a certified financial planner.