Individual retirement accounts (IRAs) have proven to be a very popular investment option.  When set-up properly, IRAs can provide investors with greater flexibility and overall wealth management opportunities than traditional retirement accounts such as 401(k) and 403(b) accounts.

That said, experience has shown that far too often IRA accounts are not set-up or managed properly, resulting in costly results for investors.  Common mistakes include improperly titled accounts, ineffective use of beneficiary designations, and failing to integrate an investor’s IRA with their overall estate plan.

Improperly titled accounts

The issue of improperly titled accounts arises most often in connection with inherited retirement accounts and inherited IRAs.  Failure to properly title an inherited account may result in immediate taxation of the entire accountand, accordingly, the loss of the benefits of tax-deferral.

The general rule with regard to inherited retirement accounts is that the inherited IRA account must be set up to indicate that it is an inherited account.  This is required to ensure that certain restrictions on inherited accounts are followed. For example, one way of properly titling an inherited IRA would be as follows, “John Doe, deceased IRA f/b/o Jane Doe.” (f/b/o stands for “for benefit of”)

I’ve seen far too many cases where errors have occurred in titling inherited IRAs. I would strongly recommend consulting with an attorney or other professional experienced in such matters to ensure that no mistakes are made.  At the very least, an investor should insist on reviewing the titling paperwork before approving the actual transfer of funds.

Beneficiary Designations

From a wealth management perspective, the choice of beneficiary designations is one of the most important decisions an IRA owner will make.  By carefully considering the choice of beneficiaries, an IRA owner can maximize the tax-deferral benefits available with an IRA and, thus, the potential financial benefits to the beneficiaries.

Back during my securities compliance days, I would see numerous IRA applications with “estate” marked as the IRA’s beneficiary. Choosing “estate” as an IRA’s beneficiary should be the last option for most IRA owners, as it precludes any opportunity to “stretch” the IRA to maximize the benefits of tax-deferral for the IRA beneficiaries.

An IRA owner should obviously choose the beneficiaries that they want to provide for and protect.  That said, there are various ways to accomplish this goal and still maximize the utility of the IRA itself.  The key is to carefully consider one’s choice of beneficiaries and to consult with an attorney or other professional experienced in such matters in order to prevent potentially costly mistakes.

Integrating IRAs With Estate Plans

The distribution of an IRA is governed by the IRA’s beneficiary designation forms, not by the terms of the IRA owner’s will  Let me repeat that. The distribution of an IRA is governed by the IRA’s beneficiary designation forms, not by the terms of the IRA owner’s will.

This is one reason why IRA owners should review their IRA beneficiary forms on a regular basis, at least annually and after significant events, to ensure that the forms reflect their true desires. There are numerous cases where ex-spouses inherited large IRAs instead of current spouses or children simply because the IRA owner never updated the IRA beneficiary forms.

I have been involved in a number of cases involving this issue, where the results were clearly inequitable and not at all what the deceased would have wanted. This is exactly why it is so important for people to have their entire estate plan, including retirement plans, reviewed by an attorney to ensure that their wishes will be carried out. I’ve seen too many cases where people have said that they talked to their accountant or financial adviser and they said everything was proper, only to find out that the advice they received was incorrect.

Failure to properly integrate IRAs and other retirement accounts can result in disastrous results,  in some cases even splitting families apart due to an unintended inequitable division of property. Properly integrating estate plans with retirement accounts and IRAs often involves setting up separate beneficiary accounts within the retirement accounts and IRAs to ensure maximum benefits to the beneficiaries.  Properly integrating estate plans with retirement plans allows a client to provide for each heir and beneficiary in accordance with their true wishes.

One last situation needs to be discussed.  With the increase in the number of mergers within the financial services industry, I have seen an increase in the number of situations where banks and brokerages have been unable to find the beneficiary forms for accounts.  Depending on the firm’s policy, the inability to locate a customer’s beneficiary forms may result in the institution paying the account’s assets to the customer’s estate which, as we mentioned earlier, is the worst option for both the account owner and their beneficiaries.

I tell my clients to always get a copy of the beneficiary forms for their accounts.  In many cases I draft personalized beneficiary forms for my clients to accommodate their particular situations.  In such cases, I always instruct the client to not only get a second original of the executed document, but also to get the financial institution to sign a document acknowledging receipt of the personalized beneficiary form.

I recommend that my clients review their retirement accounts and beneficiary forms on a regular basis, especially after significant events such as births, deaths and divorces and mergers involving their financial institutions. I also review my clients’ retirement accounts with regard to issues such as the account’s default beneficiary designation policy and the flexibility and investment options available to beneficiaries after the account owner’s death.

Retirement accounts are often a person’s largest financial asset. Yet, in too many cases, little or no consideration is given to properly establishing and managing the account. In some case, this is because the account owner is not given sufficient information about the account and the potential impact of their decisions.  In other cases, the account owner is simply overwhelmed and confused and acts quickly to just get the ordeal over with.

Integrating one’s estate plan with their retirement accounts is necessary if one wants to ensure that their final wishes are accomplished. Someone at one of my presentations suggested that this was a subject where an ounce of prevention was truly worth a pound of cure. I quickly pointed out that that was not really accurate, as in most instances, a mistake in this area might not be curable at all since it normally requires the approval of the Internal Revenue Service.

The better option is to take the time to get it right the first time and work with an attorney or someone who is both experienced and knowledgeable in such matters.  While the time and cost should not be prohibitive, the peace of mind in knowing that your affairs have been properly set-up to provide for your heirs and beneficiaries is invaluable.
– Jim Watkins