Wealth Preservation and Those Pesky 401(k)/403(b)/IRA Beneficiary Forms

Everybody hates paperwork. So when employees and investors are asked to fill out all the paperwork associated with 401(k) plans and individual retirement plans (IRAs), most people just enter something without giving it  much thought.

When I was a compliance officer, I would always cringe when I saw that the designated beneficiary was “estate.” Unless there is absolutely no other choice, choosing as the designated beneficiary on a 401(k), 403(b) or IRA is absolutely the worst choice anyone can make, as it effectively prevents the account owner’s heirs from using various options that can be used to maximize the account’s value through the use of “stretch” options and individual inherited accounts. Fortunately, the owner of the 401(k), 403(b) or IRA can always go back and execute a new beneficiary form to address such issues.

Beneficiary forms present other issues for retirement account owners. One often overlooked issue is the question of whether the custodian of the retirement account still has the account owner’s beneficiary form on file. Clients are often surprised when I suggest that they confirm that their custodian can produce their beneficiary and provide the client with a certified copy of the beneficiary form. They are even more surprised when the custodian cannot comply with the request.

With all the mergers and consolidation that has occurred in the financial services industry over the past few years, it is not unusual for a custodian to be unable to produce the retirement account’s beneficiary form. Unfortunately, it is not uncommon for custodian’s to have a policy dictating that in the absence of a beneficiary form, the default beneficiary is the account owner’s estate, regardless of who is at fault for the inability to produce the beneficiary. First year law school – the large print giveth, and the small print taketh away.

I usually handle one or two cases a year involving a custodian’s inability to produce the beneficiary form for an account. The potential implications for the owner’s heirs, both in terms of taxes and honoring the owner’s wishes, can be significant.

By requesting a certified copy of the account’s beneficiary form, the account owner can verify that the custodian has a copy of the account’s beneficiary form and obtain a certified copy of same, ensuring avoidance of the “estate as beneficiary” problem. In the event that the custodian is unable to produce the original beneficiary form, the account owner can execute a new beneficiary form and have the custodian provide them with a certified copy of same.

Owners of retirement accounts often name their spouse as the primary beneficiary of the retirement accounts. Owners should always name a contingent beneficiary or beneficiaries, if possible, so as to avoid the “estate as beneficiary” problem. Owners often name their children as contingent beneficiaries. I strongly recommend that owners wishing to name multiple beneficiaries and/or non-human beneficiaries, e.g., trusts or foundations, consult with counsel experienced in retirement account law, as there are various issues which, if not properly addressed, can prevent the owner’s original wishes from being accomplished.

Banks and other retirement account custodians often refuse to use anything other than their standardized, “cookie cutter” forms. Unfortunately, such standardized form often do not properly address the potential tax and inheritance issues involved with multiple beneficiaries and non-human beneficiaries.

Proper counsel can draft the beneficiary forms needed to protect the account owner and ensure that his wishes are accomplished. Some custodians will work with an owner’s counsel on such issues, others will not. By addressing such issues and identifying difficult custodians who do respect the account owner’s wished, the account owner can find a better custodian for the account.

Account owners should never accept a custodian’s representations regarding retirement account law as the final word on the subject. From experience, both as an attorney and a former compliance director for several broker-dealers, I can tell you that the consistency and accuracy of a custodian’s internal operations staff can vary widely, even day-to-day. Sad, but true.

Retirement accounts are often a major asset in one’s estate. Consequently, retirement account owners need to either take the time to carefully read retirement account documents to retain counsel to read and interpret such documents in order to prevent unwanted tax issues and to ensure that the account owner’s wishes are accomplished.

Retirement account owners should also review the beneficiary forms for such accounts on a regular basis to ensure that they still reflect the owner’s wishes. There are several cases where ex-wives have received the proceeds of their ex-husband’s retirement account because the ex-husband forgot to execute a new beneficiary account form for the account. In the leading case on this issue, Kennedy v. Kennedy, the U.S. Supreme Court ruled that although the ex-husband’s will left the retirement account to his new wife, the beneficiary form on retirement related accounts controls the disposition of the retirement account, not the terms of any will left by the retirement account’s owner.

This article is not designed or intended to provide legal, investment, or other professional advice since such advice always requires consideration of individual circumstances. If legal, investment, or other professional assistance is needed, the services of an attorney or other professional advisor should be sought.

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