Beneficiary Designation Mistakes Can Cost You

Beneficiary Mistakes

Most of us have filled out beneficiary forms for IRAs, retirement plans, bank accounts, life insurance policies as well as other financial instruments.  While it seems simple enough, these are some of the most important financial decisions we make.  In a recent Private Letter Ruling from the IRS, we learn of a situation where mistakes were made with beneficiaries that ended up in disaster.

Fact Pattern

  1. Husband has an IRA and names his wife as the beneficiary.
  2. Husband dies and the wife becomes the owner of the IRA.
  3. Wife, as the new owner, updates the beneficiary forms and names the family trust as beneficiary.
  4. She also uses her power of appointment to name each of the children as trustees of the trust.
  5. Wife dies, and the IRA becomes an inherited IRA for the benefit of the Trust, with children as the Trustees.

What Happened Next
The kids, as Trustees, go to trade stock, and the custodian allegedly tells them they can’t do it in this account and would need to open a new account. Following the advice of custodian, the Trustees open a Non-IRA account and transfer the assets into this account. A few months later, the Trustees realize this would be a taxable event, so they go to reverse this and move the money back to the IRA.

What did the IRS Say?
While individuals may have 60 days to rollover IRA assets back to an IRA, “Assets in an inherited IRA for the benefit of a trust are not permitted to be rolled over under section 408(d)(3). The only permitted method of transferring assets from an inherited IRA to another inherited IRA is via a trustee-to- trustee transfer, which requires a direct transfer from one IRA to another IRA.”

What are the consequences?
As a result, the entire amount that was originally transferred out of the inherited IRA is taxable as ordinary income. In addition, because this was trust owned, it is taxed at the Trust rates vs the individual rates of the beneficiaries.

Naming beneficiaries seem simple, but they can have enormous consequences. It is generally a good idea to review your beneficiary designations on an annual basis and seek the counsel of advisors who understand their consequences.

Read the Private Letter Ruling

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Sev Meneshian, CFP®

Director of Financial Planning

Sev is a Certified Financial Planner® Practitioner and an adjunct professor of retirement planning at Northwestern University. His primary responsibilities are optimizing financial plans that align with the goals of our clients as their lives unfold and their needs evolve. He holds series 65 and is registered in CA, IL, IN, WI.

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He works with successful professionals, families and executives of privately owned companies to design and implement wealth preservation & tax planning strategies.  He frequently collaborates with business and estate planning attorneys, utilizing their knowledge and experience to best serve the needs of his clients.

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