Did you know that your IRA beneficiary supersedes your will? No matter how carefully you’ve crafted your last intentions in your will, an outdated IRA beneficiary that was never updated after your divorce can unwittingly bestow your former spouse with all of your IRA inheritance, while also disinheriting your new spouse and children. That’s why it’s important to update your beneficiaries after major life changes such as marriage, divorce, births, illness, domestic issues and deaths.
While you’re at it, make sure to check how the beneficiary form reads too. Most will default to either a “per stirpes” designation or a “per capita” designation. Knowing the difference in these two designations is important, as is making sure you understand what the form you’re signing defaults to, so you can override it if necessary.
Both of these designations refer to what happens if one of your beneficiaries is no longer living. A per stirpes designation means that if one of your IRA beneficiaries is deceased, the deceased person’s children will receive his or her share. Imagine you have two children – a son and a daughter – to whom you’ve split your IRA beneficiaries 50/50. Your daughter has two daughters and your son has two sons. At your death, if your son has not survived you, your two grandsons would receive his share of the IRA. Your daughter would receive 50% of the IRA and your grandsons would each receive 25%. Keep in mind that if your son had no heirs, the entire balance would go to your daughter.
A per capita designation does not look along the lineal lines. Instead, if one of your beneficiaries is deceased, the proceeds are distributed to the other beneficiaries as if the deceased beneficiary was not to inherit any, regardless of whether or not he/she had children. Imagine you have three children, and each is to receive a third of your IRA. If one child predeceases you, the IRA would go equally to the living two children.
What if none of your primary beneficiaries survive you (and either you selected per stirpes but your beneficiaries have no children, or you selected per capita)? That’s when the contingent beneficiaries become important. Your IRA money will go to your contingent beneficiaries only if no primary beneficiaries survive you. If you want to ensure that one of your heirs receives a portion of the IRA, you must name him/her as a primary beneficiary.
Why can’t you just avoid this whole beneficiary form and let the will name your beneficiaries? You can, but your estate is not considered a person under the law, and therefore beneficiaries will have limitations to how long they can stretch out distributions from the IRA. They will not be allowed to stretch the distributions out over their lifetimes, which will result in losing valuable tax-deferred growth. Review your beneficiaries with your financial advisor to ensure the are aligned with your intentions.