“Learn from the mistakes of others. You can’t live long enough to make them all yourself.” – Eleanor Roosevelt
The long and steady demise of traditional pension plans in the U.S. private sector has given rise to a surge in assets held by participant-directed retirement accounts like 401(k)s and IRA accounts. According to the Investment Company Institute, Americans held $13.2 trillion in IRAs and $10.4 trillion in defined contribution retirement assets as of March 31. Aside from the responsibility to direct the investments, account holders have another critically important duty that all too often gets messed up: naming a beneficiary. Forgetting or fouling up this simple chore can have unexpected and sometimes unfortunate consequences.
Retirement accounts fall into a category of assets that pass to heirs directly outside of the will and are not subject to probate. That is, if the paperwork is in order. When enrolling in a retirement plan or establishing an IRA account, the holder should stipulate the person or persons who should receive the assets upon their death, known as the beneficiaries. If done correctly, the assets pass seamlessly to the intended heirs without the time and expense of probate and retain some degree of their tax-advantaged status after the transfer. If not done correctly or neglected, bad things can, and too often do happen. Here are some of the most common mistakes.
Failing to name a beneficiary. This is the most basic and ironically the most frequent mistake investors make when enrolling in their employer’s plan or rolling over their plan assets to an IRA. According to retirement plan administrator Asensus, over one third of all IRA death claims submitted for processing lack a named beneficiary. In such cases, instead of transmitting directly to heirs, the account flows into the decedent’s estate, where all kinds of mischief can ensue.
The retirement assets are now subject to the dictates of the will and must be probated, at often significant cost and delay. In addition, while an inherited IRA with a properly identified beneficiary can generally be distributed over 10 years, the maximum window in an estate shrinks to five years, and the tax rate is often much higher for the estate. Furthermore, the IRA or 401(k) money is now available to creditors of the estate. And until the account is fully distributed, the estate remains open and must file tax returns. Oh, and if you have no will, the state decides who gets the money. Oops.