IRA beneficiary designations are a confusing topic to many clients and even to some advisors, but mastering the details of IRA beneficiary rules can strengthen relationships with clients, reduce income taxes and estate taxes, and ensure that a family's financial legacy passes properly to the next generation.
In becoming an IRA beneficiary designation guru, Dave Polstra of Polstra & Dardaman, LLC, of Norcross, Georgia, learned that clients could suffer serious financial harm unless they pay attention to details on IRA beneficiary designation forms. Specifically, Polstra says, clients and advisors must pay closer attention to the fine print on IRA beneficiary designation forms.
With final IRA distribution regulations becoming mandatory in January, IRA beneficiary designation forms are about to be revised by many institutions, and advisors need to examine these forms to be sure the revisions are aligned with your customers' interests. Creating a beneficiary designation form that is flexible and that protects IRA owners and their heirs could place greater administrative burdens on the IRA custodians. It also would cost money to implement, so the custodians in the past have not always created beneficiary forms giving IRA owners the best choices. Polstra has read the fine print on some of these forms and offers tips to advisors on this complex area.
What's your beef with beneficiary designation forms? My main beef is that advisors take these forms for granted. So often they are filled out at the last minute, at the end of transactions, and many times there is not a lot of thought and care that goes into these papers.
While I want to focus your comments on IRA beneficiary forms, it's probably not a bad idea to just touch on how IRA beneficiary designation rules overlap with estate planning. It is absolutely imperative that IRA beneficiary designations be coordinated with a client's overall estate plan and other estate planning documents and with estate equalization. In estate equalization, you want an equal amount of assets in each spouse's name individually to fund the estate tax exemption amount of $1 million per individual. When we have IRA assets involved, that task becomes difficult. For instance, take a retired couple where the man has $1 million in an IRA and the couple has $1 million of other non-IRA assets. The inclination is to put all the non-IRA assets into the other spouse's name who does not own the IRA. People fail to realize that 11 out of 12 times the husband dies first. The problem is that if the husband dies first and he has named his wife as beneficiary of his IRA, his IRA goes directly to his spouse upon his death and his $1 million estate tax exemption is wasted. An alternative plan would have been for the IRA to have been made payable to a Credit Shelter Trust (CST). Or better yet, he could name his wife as the primary beneficiary of the IRA and add the CST as a secondary beneficiary. Upon the husband's death, the wife could disclaim part or all of her husband's IRA, and the IRA would pass to the CST. Since the wife is the primary beneficiary of the CST, she would get the benefits of the IRA. [Using] this strategy, her husband's estate tax exemption would be fully utilized.
Disclaiming to a CST does have advantages and disadvantages. The advantage is that you can maximize estate exemptions; the disadvantage is that payouts from the trust will be based on the life expectancy of the surviving spouse. If she had done an IRA rollover and named her children as primary beneficiaries of the IRA, her children's life expectancies are much longer. You need to run the numbers and see the best alternative.
If a wife is in excellent health and [is likely to] live a long time, I would be inclined to do an IRA rollover to ensure a long stretch-out for the kids. If the wife is in poor health, the disclaimer strategy taking full advantage of the husband's estate tax exemption is better because the wife is likely not to live long enough for the stretched payout to make up for the loss of the estate tax exemption.
Keep in mind that we will now have a Republican Congress and that estate tax repeal may be made permanent. If repeal of the estate tax is accelerated, then utilizing the exemption becomes a moot point and clears up [many] planning issues. No matter what happens to the estate tax, income taxes will probably always be here and the ultimate goal of IRA distribution planning is defer, defer, defer. Assuming the beneficiary does not need the money to make living expenses, the longer you can stretch out payments, the better. Planners have to examine the issues to figure out what to write on IRA beneficiary forms.
How do you explain these complex issues to clients? We flow-chart it out. In working with estate planning attorneys for 20 years, I've seen that they are very word-oriented; they very often do not like numbers. What we help clients with is being able to take that net worth statement–which lists joint assets, individually owned assets, qualified plans, IRAs, and insurance policies–and then read their will and their IRA beneficiary designation form, and we chart it all out. The client and we can then see where all their assets flow upon their death. That creates a great discussion point when you sit down with an estate planning attorney. You can talk about retitling assets or changing beneficiaries on insurance policies or on IRAs. And it's a great service for the client. Take, for instance, a client I have who was in a second marriage. He and his wife had an elaborate set of estate planning documents written by a major law firm in the Southeast. The documents were buttoned up and tight, but when we flow-charted how the assets would go to their heirs, he was shocked that his two vacation homes went outright to his second spouse when all along he thought they would go to a QTIP trust that would ultimately pass to his children. Flow charts can help planners explain these concepts to clients and avoid bad surprises for families.
