When someone designates a beneficiary of their Individual Retirement Account (IRA), they are authorizing a transfer of their assets, which will occur at the time of their death. Assets that have a named beneficiary will not have to go through probate court. Some of the assets that typically have beneficiary designations are:
- Bank accounts;
- Investment accounts;
- Retirement accounts; and
- Life insurance policies.
A recent U.S. Tax Court Case, T.C. Memo. 2015-82, demonstrates the importance of reviewing and updating beneficiary designations.
Case Study: Taxpayer Elroy Earl Morris was the sole beneficiary of his father’s IRA at the time of his father’s death. Elroy believed that his father wanted the IRA to be shared with his two siblings. Therefore, he took the lump sum, opting not to have taxes withheld, and shared the proceeds. He did not have taxes withheld because he had received information from the secretary at a local law firm that inheritances were not taxable.
Eventually, the IRS came after Elroy for omitting a large taxable distribution from his gross income. His defense stated that he should not have to pay tax on all the money because he did not keep it. The U.S. Tax Court ruled that what he did with the money had no bearing on the case. He was ordered to pay the tax on the full amount of his father’s IRA, in addition to a penalty.
If the decedent, Elroy’s father, had updated his beneficiary designations to include all of his children, the entire mess could have been avoided. This is why it is important for the account owner to review the beneficiary form.
In Regards to Retirement Plan Accounts:
Certain life events, like a divorce or remarriage, may have unintended consequences on retirement plan accounts. If a spouse is listed as a beneficiary of a retirement plan, in most states, that will be revoked if the couple later divorces. If one intends for the ex-spouse to remain a beneficiary, they would have to elect to name them again. If the account owner remarries, their new spouse will also have certain rights to the retirement assets.
If the account owner wants their retirement plan assets to go to their children, their new spouse would have to fill out a form that waives his or her right to those assets. If the account owner has intended beneficiaries of varying ages, he may want to create separate accounts so that each of them can decide for themselves how they want to receive the money.
It is important to understand retirement plan accounts and know what options are available to the beneficiary. If the options that they offer are not suitable, perhaps something more can be done to achieve the desired outcome.
How long has it been since you reviewed the beneficiary designations on your retirement accounts?
Susan A. Moussi, CPA, CFP®, CDFA
SMD Tax & Divorce Financial Planning Consultants, Inc.