IRA beneficiary designations are one of the most misunderstood areas of estate transfers. What most people don’t know is that beneficiary designations override your Last Will and Testament.
Yes, that’s right.
Regardless of what is written in your Will, your beneficiary designation trumps your Will. Today, IRA assets can represent the lion’s share of an estate, so it is imperative that beneficiaries are named correctly.
Each financial institution has a unique default beneficiary sequence. Let’s say you have three IRAs at three different financial institutions, with no beneficiary designations. In this scenario, the IRA proceeds could conceivably be distributed in three different ways. For example, TD Ameritrade’s default IRA beneficiary is your spouse, then your children (including adopted children), in equal shares, then your parents in equal shares, then the legal representative of the estate. Fidelity’s IRA beneficiary defaults are to the surviving spouse and then to the estate. The default beneficiary sequence is listed in the IRA custodial agreement received at the time of opening the account.
Consider the court case of Smith v Marez from 2008. Leonard Smith died February 29, 2008. The North Carolina Court of Appeals case to decide who would receive the funds was decided on December 6, 2011. The time frame is worth mentioning because it took nearly 4 years to resolve this beneficiary issue.
What brought on this case?
Mr. Smith’s IRA beneficiary designation listed, “to be distributed pursuant to my last will and testament.” Because his specific children and their respective percentages were not correctly named, the beneficiary form was deemed invalid. By default, the funds were distributed by Pershing, the fund’s custodian, in full to Mr. Smith’s current wife of 2 months. The value of IRA was $400,000! This is a huge unintentional mistake that can devastate families in an already emotionally charged time.
The best way to protect yourself from mistakes is to make sure you have copies of your beneficiary designations, along with the IRA custodial agreement, for each IRA in your name.