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Beneficiary Basics, and Beyond

Beneficiary Basics, and Beyond

When opening up retirement accounts, most advisors (and their clients) usually give little thought to the process of completing the “beneficiary” section of the paperwork.

Fewer still perform any ongoing review of the designations, regardless of any changes in the retirement account owner's situation.

But a failure to properly establish and monitor the beneficiary designations can cause headaches for you and your clients, and could cost them and their heirs lost opportunities and money down the road.

Here are six ways it pays to pay attention to this oft-neglected section of your clients' retirement accounts.

  1. It matters more than most know

    In most cases, when a retirement account owner dies, the beneficiary named on the account at the time of death supersedes any directions the owner left in his will or other estate documents.

    Usually the only way the incorrect inheritor can be removed post-mortem is if it's proven that the name was inserted through means of fraud or coercion of the owner.

    It is bad enough when the designated beneficiary isn't whom the owner would have preferred at the time of the owner's death. What's worse is when the omission jeopardizes the financial security of the loved ones whom the owner would have preferred to inherit the assets.

  2. Be careful using “trust” or “estate”

    It is permissible to name a trust or the retirement account owner's estate as the beneficiary. But doing so can add complexity, and reduce flexibility.

    The benefits of having the account flow to a trust include using the assets as part of a “bypass trust” to avoid estate taxes, as well as protecting the inheritance and the inheritors from future negative developments.

    But the designation needs to be continually coordinated with any future changes in the trust, a process that can require more work for your client, and fees billed from the client's estate planning attorney.

    And without diligent attention from you, the client, and the attorney, it's easy for the designation to create unintended and unfortunate circumstances by running afoul of murky and ever-changing tax and estate laws.

    Putting “estate” on the beneficiary line of a retirement account likely won't create such dire potential outcomes, and in many cases the estate may end up as the “default” beneficiary if there is no current applicable designation.

    But having the retirement account go to the estate could accelerate the pace at which beneficiaries are required to withdraw funds from the account, which could in turn boost the corresponding income tax bill higher than it otherwise would be.

  3. Add contingent beneficiaries

    An obvious reason to add contingent beneficiaries to retirement accounts is in case the primary beneficiary dies before the retirement account owner, and before the owner has a chance to update the designation.

    A more sophisticated justification is that the existence of contingent beneficiaries gives the primary beneficiary the option of “disclaiming” the inherited retirement account, and allowing it to pass on to the contingent beneficiaries.

    But the contingent beneficiaries generally need to be in place on the retirement account before the owner dies.

  4. Split up the accounts

    When a retirement account owner has more than one beneficiary in mind, often the easiest route is to simply split up one account using percentage shares that add up to “100.”

    But after the retirement account owner dies, multiple non-spouse beneficiaries of one retirement account may have to begin taking RMDs according to the life expectancy of the oldest beneficiary.

    It's not a big issue if all of the beneficiaries are close to each other in age. However, if the age range of the inheritors spans several decades, the RMDs (and the income tax bill from the RMDs) could be much larger than if the account had been split up according to each designated beneficiary before the owner died.

    It may be possible to split up the account during a short period after the owner's death, and then use the RMD schedule that corresponds to each beneficiary.

    But it's probably more prudent to address the issue with the IRA owner now, while he's able to have input on the eventual outcome.

  5. Do the beneficiaries a big favor

    Don't limit your questions about designated beneficiaries to just name, birth date, and Social Security number. At a minimum, more knowledge about them makes it more likely that you'll maintain the relationship (and assets) in the future.

    More importantly, you might find out a way to save the wealthier beneficiaries a bundle in future income taxes — which should really get you in their good graces.

    The solution is to suggest that the older IRA owners who are in a lower tax bracket now convert their IRA to a Roth IRA, and pay any ensuing income taxes at their lower rate.

    Once the Roth IRA owner passes away, the beneficiaries are still required to make required minimum distributions (RMDs) from the inherited Roth IRA, according the normal IRS life expectancy tables.

    But of course the distributions will be tax free. And other than the RMDs, any funds not needed by the beneficiary can remain in the Roth IRA, sheltered from taxation.

    When appropriate, well-heeled beneficiaries may even offer to reimburse the older IRA owners to cover the tax incurred on the conversion, subject to the annual gift tax laws.

  6. Give away the IRA

    Clients who intend to bequeath some of their assets to charity, as well as to family members or friends, may save a significant amount in eventual income taxes by leaving IRA accounts to the charity, and non-IRA money to the individuals.

The reason? When the qualified charity liquidates the IRA, it won't pay any income taxes on the amount, and any estate tax liability may benefit from the corresponding charitable deduction from the donation.

The individuals inheriting the non-IRA assets will be especially pleased if their inherited assets have a high amount of unrealized capital gains, and the heirs can “step-up” the cost basis of the assets.


Kevin McKinley CFP is Principal/Owner of McKinley Money LLC, an independent registered investment advisor. He is also the author of the book, Make Your Kid A Millionaire (Simon & Schuster), and provides speaking and consulting services on family financial planning topics. Find out more at

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