With IRAs read the fine print
The devil is in the details, as they say, and, with IRAs, it pays to read the fine print. It’s usually the custodial agreement of your IRA that is overlooked. So, even though you are busy considering the investment options of your new IRA and being sure your rollover won’t run afoul of any tax rules, you also need to ask some questions about the details of the custodial agreement you will have with the bank, brokerage or mutual fund.
Many people assume that an IRA custodial agreement must match the Internal Revenue Service rules and regulations. But custodial agreements can be more restrictive. Here are some considerations and questions you should ask before signing.
1. Stretch IRAs
As you may know, IRS rules allow the beneficiary or beneficiaries who inherit an IRA to name their own beneficiaries, most commonly a child, and this can be very financially beneficial. For example, if Peter inherits his dad’s IRA, he can “stretch out” the tax deferral by making minimum distributions over his life. He can name his daughter Susie as his beneficiary, and she can do the same thing after her grandfather dies, thus continuing the tax deferral.[Benedetti e-mail review]
But, in a few cases, the IRA custodian may not permit the beneficiary to name a successor beneficiary. So, when the owner dies, the IRA assets must be paid out to the owner’s estate in a lump sum, causing the loss of deferral and an immediate, and potentially large, tax bill.
2. When a Beneficiary Dies Before You
Another provision to check for is what happens if you have multiple beneficiaries named to an IRA, such as your adult children, and one of them dies before you do. The standard language of custodial agreements call for IRA assets to pass to the remaining beneficiary or beneficiaries upon the owner’s death “per capita.” That means the assets are divided only among the surviving beneficiaries.
But what if a prematurely deceased beneficiary had children? Under the per capita default, no IRA assets would pass to those children. The assets would pass only to the surviving beneficiaries. Essentially, you disinherited some of your grandchildren.
This oversight can be avoided if the language of the agreement says “per stirpes” instead of per capita. “Per stirpes” allows the share that would have gone to the deceased beneficiary to be passed to the deceased’s children (or other designated heirs of the deceased).
Some custodial agreements that have the per capita provision as a default allow you to check a box on the agreement form changing it to “per stirpes.” In other cases, you may have to draft a signed and witnessed custom addendum instructing the custodian to distribute on a per stirpes basis. It is also a good idea to have the custodian sign the addendum acknowledging receipt. If the custodian won’t accept addendums, you may want to consider a different custodian.
3. Does the wording on the custodial agreement mention multiple beneficiaries?
The “default” language of some agreements allows only one primary beneficiary or may not even mention this requirement at all, so you should ask. Another fine point is that some custodial agreements that do allow multiple beneficiaries may prescribe equal distribution of the assets. If you prefer different percentages for different beneficiaries, be sure to check into this. Again, if allowed by the custodian, you may need to attach separate language detailing multiple beneficiaries by name and how you want the assets distributed among them.
4. What if you forget to remove your former spouse as beneficiary from the IRA?
Agreements typically are silent, meaning they don’t make any stipulations on this point, though a few will automatically revoke the divorced spouse as beneficiary unless otherwise directed by a divorce decree.
5. Can the executor of your estate get information from the custodian about the IRA?
Does the agreement allow the custodian to discuss the IRA with your estate executor or successor trustee who isn’t a named IRA beneficiary? If not, you may have to write that provision into an addendum.[Forbes hard copy article , Protect Your IRA, p 254]
6. What about transfers to another financial institution after you die?
Does the agreement allow the beneficiaries to make a trustee-to-trustee transfer of the IRA assets to another financial institution after you die (thus avoiding the payment of income taxes)? If the custodian does not permit the transfer, your beneficiaries either are stuck with that custodian or would have to cash in the IRA and pay potentially substantial taxes on the lump sum.
If you are in doubt on any of the fine print, or have other questions regarding your IRA, be sure to ask your financial advisor for help.
Provided by courtesy of Herb White, MBA, CFP, Principal and Managing Director of Life Certain Wealth Strategies in
