retirement assets: traps, failures and errors

why many beneficiary forms are defective

by seymour goldberg, cpa, mba, (taxation) jd

i first became aware of the fact that many ira beneficiary forms were incomplete or defective in 1990. it was at a time that a cpa asked me to review an ira beneficiary form of a major financial institution for his client. the form provided that each child would receive 50% of the client’s ira account. i then looked to see what provisions were made in the ira beneficiary form if the child predeceased the ira owner to make sure that the child’s issue would receive the predeceased child’s share. i was shocked to discover that the ira beneficiary form provided that the surviving child would receive 100% of the ira proceeds and that the issue of the predeceased child would be cut out. flash forward, i have since corrected many canned ira beneficiary forms to date to avoid this problem.

during the last ten years or so many ira institutions have upgraded their ira beneficiary forms so that the issue of a predeceased child, if any, will receive the share allocated to the predeceased child. that’s the good news. the bad news is that there may be many ira beneficiary forms that were executed by the ira owner before the revised forms came out. that means that unless the ira owner is alert, he/she may have the old forms on file with the ira institution.

how could many ira owners make such a mistake?

it’s easy and here are some of the reasons:

1. 1. taxpayers often think that the ira assets are disposed of by their will. that’s not true for the most part since an ira is a non-probate asset and is not governed by a will. the beneficiary designation determines who is entitled to the ira proceeds upon the death of the ira owner, not the will. the exception is when there is no beneficiary designation on file with the ira institution or the ira owner for whatever reason selected his/her estate as the beneficiary of his/her in that case the ira proceeds will be governed by the will provisions unless the ira agreement provides for default beneficiaries.
   2. it is possible that a number of ira institutions may need to upgrade their beneficiary forms to provide for the predeceased child situation previously
   3. a number of ira institutions have sophisticated beneficiary forms that are excellent. the problem there is that they are so sophisticated that they are difficult for the average person to follow.
   4. many taxpayers are intimidated by ira beneficiary forms and they tend not to read the fine print that is boilerplate. in essence the canned language in your ira beneficiary form acts as a will for your ira
   5. failure to timely prepare and implement traditional ira and roth ira beneficiary forms with the ira institution(s) maintaining the ira account(s). this applies to ira owner(s) and the beneficiary of inherited ira account(s) (traditional and roth).  the beneficiary of an inherited ira should prepare a beneficiary form for the inherited ira account as soon as possible after the death of the ira owner.

in my practice, we’ve found the following additional errors or issues:

1. 1. an ira owner died and had approximately $500,000 in his ira. the designated beneficiary of his ira was child number 1 as his primary beneficiary and child number 2 as his secondary beneficiary.  child number 1 received the $500,000 ira in a lump sum and child number 2 received nothing.  it is interesting to note that the decedent intended to leave his assets to both children equally based upon his will provisions.
   2. an ira owner listed only a few of his children as the primary beneficiaries of his ira but left out a number of children as primary beneficiaries of his ira. i asked him why he did that, and he told me that he thought that his will governed who would receive his ira assets.
   3. another ira owner left out most of his children as beneficiaries of his ira. the ira form only had a few spaces on it for primary beneficiaries.  he therefore cut out most of his children as beneficiaries of his ira.
   4. another ira owner listed a child and his wife as primary beneficiaries and all his other children as contingent beneficiaries. he told me that the form did not have enough spaces and he didn’t realize what he was doing.
   5. another ira owner established a trust for the benefit of his grandchild as the beneficiary of his substantial ira and filed this beneficiary designation form with the financial institution. the original beneficiary of his (substantial) ira was his daughter who did not need the funds.  this was in effect a generation-skipping transaction and part of his estate plan.  two years later he found out that the beneficiary of his ira was still his daughter.  i looked into it and found that the revised ira beneficiary form listing the trust as the beneficiary was still sitting in his financial advisor’s desk.  the financial advisor forgot to forward it to the ira retirement area of the financial institution.
   6. another ira owner listed each of his two children as contingent beneficiaries on all of his ira accounts. each child as a contingent beneficiary had a 50% interest in his ira.  the ira owner added the words “per stirpes” next to each child’s name.  the legal effect of the words “per stirpes” means that if a child predeceases the ira owner, then such child’s share is then payable to the issue of that predeceased child.  the ira owner misplaced three of his ira beneficiary forms and contacted the three institutions that maintained these ira accounts for confirmation as to the beneficiaries of his ira.  all three institutions sent back letters confirming the primary and contingent beneficiaries of his ira accounts.  however, none of the confirmation letters mentioned “per stirpes.” the ira owner insisted on receiving the actual copies of his ira beneficiary forms from each of these three institutions.  believe it or not, the actual ira beneficiary forms did in fact have the words “per stirpes” next to each child’s name.  the confirmation letters were obviously incorrect.  this case was a wake-up experience for us. no further comment.
   7. another ira owner updated his ira beneficiary form with a financial institution and added the words “per stirpes” next to each child’s name. the financial institution rejected the form because the financial institution’s policy is to not permit the words “per stirpes” to be used.  s. – the financial institution lost a major account.  two other ira owners had the same experience with the same financial institution.
   8. another ira owner selected a trust for the benefit of a child as the beneficiary of his ira. the financial institution rejected the form because the institution, for whatever reason, did not wish to have a trust as the beneficiary of the ira.  again, the financial institution lost the account.  another ira owner had the same experience with the same financial institution.
   9. another ira owner listed minor beneficiaries directly as the beneficiary of his ira. on his death legal problems were triggered and the stretch payment rules were lost because of potential legal cost issues.  had provisions for the minor been done in another manner, then the ira stretch payment rules would have been saved.
   10. another ira owner came to me with a letter from the financial institution requesting that she fill out another ira beneficiary form. i knew that she had previously prepared a beneficiary form with the financial institution when she opened the ira account.  i called the ira institution and was told that a number of ira beneficiary forms were lost and that it was therefore necessary to update the ira beneficiary form.
   11. another ira owner had prepared a detailed ira beneficiary form in a manner that i had suggested. at a later date the financial advisor moved to another financial institution and transferred the ira to the other financial institution.  the financial advisor had the ira owner prepare a new ira beneficiary form that was incorrect.  i caught it and modified the new ira beneficiary form.
   12. another ira owner had set up a trust for the benefit of his wife as the beneficiary of his ira. the purpose of the trust as the ira beneficiary was to save his estate tax exemption.  at a later date the financial advisor moved to another financial institution and transferred the ira to the other financial institution.  the ira owner then made the wife the direct beneficiary of his ira instead of a trust for the benefit of his wife.  this change was done without my knowledge.  he subsequently died and the estate tax exemption was lost.  the wife stated that she did not wish to do anything about it because the financial advisor was a close relative and a major beneficiary of her will.
   13. most of the ira beneficiary forms that i have reviewed over the last 20 years or so had to be amended for several reasons. i often ask clients to read the fine print on their existing ira beneficiary forms.  after that i explain the effect of the ira beneficiary form language to the client.  for the most part i suggest that the issue of a predeceased child should receive the predeceased child’s share.  the client generally agrees to make the change.  most taxpayers do not realize the legal consequences of their existing ira beneficiary forms.
   14. many ira owners have misplaced their ira beneficiary forms. at my insistence they obtain copies of the ira beneficiary forms from their ira institutions.  i have found that a few clients never selected any beneficiaries for some of their existing ira accounts.
   15. many individuals have sole proprietorship keogh plans. i’ve found on occasion that there is no beneficiary form on file with anyone or that the form is lost or misplaced.
   16. an ira owner should not fill out an ira beneficiary form that designates the beneficiary “as stated in my will” or words to that effect. according to the irs the beneficiary under the will cannot use his or her life expectancy in determining required minimum distributions from the deceased ira owner’s account.  see irs letter ruling 200846028 dated august 20, 2008.
   17. a client executed and dated a customized beneficiary form listing four trusts by percentages as the beneficiaries of her significant roth ira account. the customized beneficiary form was given to the financial advisor for processing.  about a year later after the death of her husband i asked her to send me a copy of her beneficiary form for my files.  she did not have a copy so we asked the financial institution for a copy.  the financial institution confirmed that there was no beneficiary form on file with the financial institution.  the default beneficiary under the ira custodial agreement was her surviving spouse and if none then her estate.  the initial customized beneficiary form was never located.  we immediately had the client execute and date a new customized beneficiary form listing the four trusts by percentages as the beneficiaries of her significant roth ira account.
   18. one financial institution does not permit per stirpes designations. it provides in the beneficiary designation form the following language: “i designate that upon my death, the assets in this account be paid to the beneficiaries below.  the interest of any beneficiary that predeceases me terminates completely, and the percentage share of any remaining beneficiaries will be increased on a pro rata basis.  if no beneficiaries are named, my estate will be my beneficiary.”

comments

the ira owner should periodically review his/her ira beneficiary forms that are on file with the ira institution and make the appropriate modifications when necessary.

in addition, the ira owner should send copies of the ira beneficiary form to the ira institution in duplicate and ask for a receipted copy to be sent back to him/her.

the ira owner should check to see how flexible the ira institution is with respect to adding language to the canned ira beneficiary form.  if the ira institution is not flexible and the modifications to the form are important to you, then consider using another financial institution that is more flexible.

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common errors in retirement distribution planning

in general, the following common errors often take place when dealing with the retirement distribution rules from an estate planning point of view:

1. 1. failure to timely update and/or review your existing beneficiary forms on file with the ira institution and the employer-sponsored retirement plan.
   2. failure to periodically review your existing legal instruments to determine whether the retirement assets are charged with an allocable portion of the estate tax upon your death or are exonerated from the estate tax liability allocable to the retirement assets. if exonerated, ensure that there are sufficient other assets to pay the estate tax allocable to the retirement assets.
   3. exonerating the retirement assets from any estate tax liability will permit more tax-deferred growth of the retirement assets and tax-free growth of roth iras. however, this exoneration approach is at the expense of other beneficiaries of the estate.
   4. failure to do an estimated estate tax liquidity analysis to determine the extent of your estate tax liability and the source of payment of the estate tax liability.
   5. failure of your beneficiaries to know how the inherited ira distribution rules work after your death.
   6. failure of your surviving spouse to know about the spousal rollover rules or direct transfer rules after your death.
   7. failure of your surviving spouse to timely implement the spousal rollover rules or direct transfer rules after your death.
   8. failure to know that an unpaid required minimum distribution must be paid for the year of death of the plan participant or ira owner.
   9. failure to know that roth iras are subject to post-death required minimum distribution rules.
   10. failure to know that retirement distribution post-death payments paid to a beneficiary are generally not subject to the irs 10 percent early distribution penalty.
   11. failure to know that the balance in an inherited ira account is included in the gross estate of the beneficiary for estate tax purposes when the beneficiary subsequently dies. this can be avoided if a trust is the beneficiary of the ira owner’s account.
   12. failure to know that an ira beneficiary may timely disclaim an inherited ira.
   13. failure to know that a minor should not generally be directly designated as the beneficiary of a retirement account.
   14. failure to use the uniform transfers to minors act in a manner permitted under state law as the beneficiary of an ira account.
   15. failure to have a power of attorney that provides for the retirement distribution transactions, including rollovers and beneficiary designations.
   16. failure of your beneficiaries to know about the separate account rule if there are multiple beneficiaries of your retirement accounts.
   17. failure to know that a rollover from a previously tax-qualified plan that has not been timely updated is not valid and subject to significant irs penalties.
   18. failure to know that a specifically designed trust may be the beneficiary of retirement assets provided that the irs rules are satisfied.
   19. failure to know that irs penalties apply to beneficiaries of inherited iras when post-death required minimum distributions are not timely made.
   20. failure to maintain paperwork on the inherited payout period for the beneficiaries.
   21. failure to know that the federal estate tax attributable to retirement accounts may be deducted by the beneficiaries on a pro-rata basis.
   22. failure to know how the ira trust works when the beneficiary of an ira is a trust.
   23. failure to know that certain irs trust documentation requirements must be satisfied with the ira financial institution by no later than october 31st of the year following the ira owner’s death.
   24. failure to know that the pension protection act of 2006 permits a non-spouse beneficiary of an eligible retirement plan to establish an inherited ira.  certain trusts may qualify for this relief as well.  these provisions apply to non-spouse beneficiaries with respect to amounts payable from a qualified retirement plan, governmental section 457 plan, and a 403(b) tax-sheltered annuity.  if the paperwork is done correctly and spousal consent, if applicable, is obtained, then a trust can be the beneficiary of a participant’s death benefit from an eligible retirement plan. according to the irs the provision was optional under the 2006 act and not mandatory.  however, under the worker, retiree, and employer recovery act of 2008 (wrera) this provision is mandatory for plan years commencing after december 31, 2009.
   25. failure to know about the one-per-year limit on ira rollovers. see irs announcement 2014-32.
   26. failure to know that the surviving spouse may not rollover a required minimum distribution attributable to the deceased (spouse) ira owner.
   27. failure to know that roth ira conversions can no longer be recharacterized under the tax cuts and jobs act.
   28. failure to file irs form 5329 with the irs when there is a client who has not taken required minimum distributions.
   29. failure to be aware of the statute of limitations issues if irs form 5329 is not filed for the client who has not taken required minimum distributions.
   30. failure to be aware of the personal liability of the fiduciary for debts to the u.s. government on death of ira owner or death of ira beneficiary if unpaid required minimum distributions were not taken by ira owner or the beneficiary of the inherited ira as the case may be.
   31. failure to timely prepare a customized designation of beneficiary form for a trust as the beneficiary of an ira account holder (traditional and roth).
   32. failure to timely prepare a successor-in-interest designation of beneficiary form for an inherited ira account holder. if not done, then the default beneficiary under the ira agreement becomes the successor beneficiary.
   33. failure to recognize that many designation of beneficiary forms use per capita instead of per stirpes.
   34. failure review existing designation of beneficiary forms when implementing an estate plan.
   35. failure to list basis in roth ira account(s) on schedule a of form 8971.
   36. failure to list basis in plan accounts and 403(b) arrangements on schedule a of form 8971.
   37. failure to list basis in bifurcated assets such as a non-qualifying annuity on schedule a of form 8971.
   38. failure to list basis in traditional ira account(s) that contain after-tax dollars resulting from non deductible contributions made to a traditional ira on schedule a of form 8971.
   39. failure of ira owner (traditional and roth) to maintain permanent file of beneficiaries of all ira accounts. this also applies, for example, to 403(b) arrangements, 401(k) plans, keogh plans, other qualified plans, a 457 governmental plan, annuities, life insurance policies and deferred compensation agreements.

 

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major sections

1. 1. common errors in retirement distribution planning
   2. why many beneficiary forms are defective
   3. unintended beneficiaries of retirement accounts.
   4. important ira beneficiary state court cases
   5. customized sample beneficiary forms
   6. advantages of trusts as ira beneficiary
   7. disadvantages of trusts as ira beneficiary
   8. ira beneficiaries and unpaid estate tax liabilities
   9. creditor rights and inherited iras under state law
   10. danger zone: practitioner tips in avoiding use of revocable trusts as an ira beneficiary where appropriate
   11. ira custodial agreements and default beneficiaries
   12. waiver of penalty rules under secure
   13. special separate account rules when there are multiple beneficiaries of a deceased ira owner’s account
   14. what happens when attorneys and other self-employed individuals with keogh plans die without nominating a successor to take charge of the keogh plan
   15. fixing common plan mistakes – using epcrs to terminate an orphan plan
   16. major change in required beginning date
   17. major irs penalty changes under secure 2.0 act of 2022
   18. major irs statute of limitation changes under secure 2.0 act of 2022
   19. comment letter to treasury department involving an oversight in drafting conduit trusts
   20. irs notice 2022-53
   21. estate tax watch article

 

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bonus sections

• unintended beneficiaries of retirement accounts, or: “my ira is going where!?” by rehberg law group, pllc

– rehberg law group is a boutique law firm in washington state that focuses exclusively on estate planning and estate & trust administration.

• important ira beneficiary state court cases
  • major adverse state court case involving the transfer of an ira account from one financial  institution to another financial institution
  • state court case involving not filling out an ira beneficiary form properly. smith v marez, (n.c. ct. app. 2011)
  • ira beneficiary malpractice case, supreme court of vermont: rachel powers v. katherine a. hayes, esq. and barr, sternberg & moss, p.c.
• customized sample beneficiary forms
  • when iras are payable to a trust to be revised by client to meet the client’s wishes

• the numerous advantages of trusts as ira beneficiary
  • practitioner tips, with summary of key court case

 

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about the author

seymour goldberg, cpa, mba, jd, is a senior partner in the law firm of goldberg & goldberg, p.c., melville, new york. professor emeritus of law and taxation at long island university. former director of the tax institute of the c.w. post campus of long island university. recipient of the american jurisprudence award in federal estate and gift taxation from st. john’s university school of law.

cle instructor for many professional organizations including the new york state bar association, american bar association, njicle, city bar center for cle, local bar associations and law schools.  mr. goldberg is admitted to practice law in new york state.

authored four manuals for the american bar association on iras and on trusts as well as for other organizations such as the aicpa on the ira distribution rules.  his first guide entitled “a professional’s guide to ira distribution rules” was published by the foundation for accounting education for the years 1993-1998.  he has been interviewed on many technical ira issues for ed slott’s ira advisor.

mr. goldberg handles probate matters, tax disputes with the irs and the irs appeals office, ira penalty waivers and new york state department of taxation tax disputes. represents clients in irs ruling requests (over 75). wrote an amicus brief in the 2014 inherited ira supreme court case, clark v. rameker.

his manuals for the american bar association can be found in well over 100 law school libraries throughout the united states. he is a member of the relations with the irs committee of the new york state society of certified public accountants.  he was formerly associated with the internal revenue service.

mr. goldberg has conducted continuing education courses with the irs on the retirement distribution rules. he has recommended corrections to irs publication 590 working pro bono with the irs and then congressman steve israel. this resulted in irs revisions and the adoption of irs publication 590-a and irs publication 590-b.

he is the recipient of outstanding discussion leader awards from both the aicpa and the foundation for accounting education. he has conducted well over 300 cpe programs in the field of taxation including over 100 cpe programs involving iras and ira compliance issues.

mr. goldberg has been quoted in the new york times, forbes, fortune, money magazine, u.s. news & world report, business week and the wall street journal. he has also been interviewed on cnn, cnbc and wcbs.

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