11-5-11 - The IRA Beneficiary Designation Form - …

1 COPYRIGHT 2011 SALVATORE J. LAMENDOLA, , Your IRA Beneficiary Designation form ( BDF ) governs the division and distribution of your IRA after you pass away. The BDF trumps all provisions in your Will and in your Living Because the BDF often governs more assets than either your Will or your Living Trust, you should think of your BDF as your second Will . THE IRA Beneficiary Designation form : HOW TO COMPLETE IT PROPERLY By Salvatore J. LaMendola, , SPECIAL REPORT Tenth Floor Columbia Center 101 West Big Beaver Road Troy, Michigan 48084-5280 (248) 457-7000 Fax (248) 457-7219 Example: Amy has a $150,000 home, a $100,000 taxable investment account, and a $500,000 IRA (payable to her son). Amy s BDF governs 75% of the total value of her estate ($500,000/$750,000). Amy decides that she no longer wishes her son (and only child) to inherit her estate.

2 Therefore, she amends her Living Trust accordingly. This takes care of the 25% that is governed by the Living Trust, but not the IRA. Amy must also amend her BDF to handle that. If she fails to do so, her son will still inherit 75% of her estate at her death. 1 Assuming that you have not named your estate, which is governed by your Will, or your Living Trust as the Beneficiary of your IRA. 2 For example, if the Designation is of A for 50%, B for 30%, and C for 20%, and if B predeceases, then A and C will receive 65% and 35%, respectively, if per capita (equal) applies, or 71% and 29%, respectively, if per capita (pro rata) applies. On the other hand, A and C will receive 50% and 20%, respectively, if per stirpes applies, with the remaining 30% going equally to B s children. 1. Understand the importance of the form . 2. Anticipate the possibility of a predeceased Beneficiary . Anticipating and addressing the unlikely events, such as a predeceased Beneficiary , is the mark of good planning.

3 A per stirpes Designation (or default provision in the IRA agreement) will allow a predeceased Beneficiary s heirs to inherit his/her share. A per capita Designation (or default provision) will allow the other beneficiaries to inherit the share, either equally or in the same proportions as they inherited their own shares (called pro rata ).2 Since practically all default provisions are per capita (see Table I below), if you want a predeceased Beneficiary s heirs to inherit his/her share, you must indicate per stirpes on your BDF. Example: Jack names his three daughters Margo, Marcy, and Monica as 1/3 beneficiaries of his $300,000 IRA. Each daughter has two children of her own. If a daughter predeceases him, Jack wants her share to pass equally to her children ( , $50,000 to each grandchild). Jack and Marcy are in a car accident. Marcy dies instantly. Jack dies a week later.

4 Margo and Monica inherit $150,000 each and Marcy s children inherit nothing. Why? Because Jack failed to indicate per stirpes for Mary s share on his BDF. 2 3. Name successor beneficiaries. The original Beneficiary is the Beneficiary who actually inherits. This could be the primary Beneficiary , if he or she survived you, or the contingent Beneficiary , if the primary Beneficiary predeceased you. The successor (or remainder ) Beneficiary inherits after the original Beneficiary dies. TABLE I SUMMARY OF DEFAULT PREDECEASED Beneficiary PROVISIONS IRA Provider3 Per Stirpes Per Capita (Equal) Per Capita (Pro Rata) Charles Schwab X Fidelity X Merrill Lynch X Morgan Stanley Smith Barney X Raymond James X TD Ameritrade X UBS X Vanguard

5 X Wells Fargo X Edward Jones X Example: Clifford wants his second wife, Jennifer, to inherit his IRA if she survives him. He therefore names Jennifer as the primary Beneficiary of his IRA. If Jennifer predeceases Clifford, then Clifford wants Reginald, his son by his first marriage, to inherit the IRA. He therefore names Reginald as the contingent Beneficiary . If Jennifer survives Clifford, and if there is a balance left in the IRA at Jennifer s death, then Clifford wants Reginald to inherit that balance at that time. He therefore also names Reginald as the successor Beneficiary of his IRA. Many custodial IRAs do not allow you to name successor beneficiaries. In that case, if the original Beneficiary dies without having named a successor Beneficiary , the default provisions will name one for him/her (see Table II below).

6 A trusteed IRA will allow you to name successor beneficiaries, but these IRAs have other As a result, using a custom drafted trust as the Beneficiary of a custodial IRA is usually the best option. 3 Inclusion is for illustration only and not an endorsement. 4 The drawbacks of trusteed IRAs include the inability of the Beneficiary to move to a different IRA provider, potentially higher fees, potentially narrower investment choices, the inability to use an individual (such as a family member) as trustee, the inability to stop all distributions to a spendthrift Beneficiary , and the inability to include customized provisions. On the other hand, trusteed IRAs avoid the complicated IRS requirements that must be met for custom drafted trusts to work and the legal fees for drafting them. They also eliminate the cost of preparing annual post-death trust income tax returns (IRS form 1041).

7 3 COPYRIGHT 2011 SALVATORE J. LAMENDOLA, , Example: Owen named his son, Parker, as the primary Beneficiary of his IRA. He named Parker s son, Chester, as the contingent Beneficiary . Five years after Owen s death, Parker dies with no successor Beneficiary named. Therefore, Susan, Parker s second wife (Chester s step-mother) inherits the IRA next. How? First, since Parker survived Owen, Chester was eliminated as a Beneficiary completely. Next, since Parker did not re-name Chester (or anyone else) as Beneficiary , the default provision controlled. It named Parker s estate. Finally, since Parker s Will left his entire estate to Susan, the balance of the IRA is Susan If, in addition to naming Chester as the contingent Beneficiary , Owen had also named Chester as the successor Beneficiary (or if Owen had used a custom drafted trust), Chester would have inherited the IRA next, not 5If Parker died intestate (without a Will), under most intestacy statutes, Susan would still inherit at least 50% of the IRA.

8 6 This assumes that Parker (or Susan acting as Parker s agent under a DPOA - more at item 10 below) would not have substituted Susan for Chester after Owen s death. With a custom drafted trust, this could not happen. Without one, it could. 7 From the Wells Fargo custodial IRA agreement. Emphasis added. However, even if the emphasized language is used to prevent the original Beneficiary s changing the original successor Beneficiary , the change could nonetheless be accomplished by a transfer to a different IRA provider. 8 Here and throughout, if a Roth IRA is involved, growth within the Roth IRA and distributions from it are tax-free. 9 For example, in 2011 a single taxpayer is taxed at 28% on taxable income between $83,601 and $174,400; at 33% on taxable income between $174,401 and $379,150; and at 35% on taxable income in excess of $379,150. TABLE II SUMMARY OF DEFAULT SUCCESSOR Beneficiary PROVISIONS IRA Provider Estate Spouse, then Estate Spouse, then Children, then Estate Spouse, then Children, then Parents.

9 Then Estate Charles Schwab X Fidelity X Merrill Lynch X Morgan Stanley Smith Barney X Raymond James X TD Ameritrade X UBS X Vanguard X Wells Fargo X Edward Jones X Language to look for: Unless a Designation filed by the Depositor and agreed to by the Custodian states otherwise, if the Beneficiary dies after the Depositor, the Beneficiary will be the person, persons, legal entity or entities designated by the Beneficiary .

10 7 4. Specify the manner of distribution. Silence allows your Beneficiary to withdraw the entire IRA all at once (called a cash-out ). This results in the immediate income taxation of the entire distribution8, usually at higher income tax rates because of bracket creep .9 4 Cash-outs also forfeit all future tax-deferred growth. By limiting a Beneficiary to annual required minimum distributions ( RMD s) which are taken over the Beneficiary s life expectancy (called a stretch-out ), the Beneficiary inherits more. 10 Assumptions: 28% income tax rate (except for 35% income tax rate on cash-out due to bracket creep ); 15% capital gains tax rate (25% of capital gains realized annually); All income and capital gains taxes paid from the investment account; All earnings in the investment account also reinvested; 39-year stretch-out period. 11Do not assume that your IRA agreement allows stretch-outs.