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Denise Appleby, CISP, CRC<em>®</em>, CRPS, CRSP, APA

Denise Appleby, CISP, CRC®, CRPS, CRSP, APA

By Denise Appleby, APA, CISP, CRPS, CRC®, CRSP

Editor’s Note:  Denise is a long-time supporter of InFRE and a fellow Certified Retirement Counselor®.  She excels at explaining IRA and employer plan rules and regulations, because not only does she know and understand the regulations, she has extensive practical experience. Here are two articles to help you with common issues that might affect your clients now and in the future. You may find out more about the planning tools she offers here.

 

I.  Help Clients Avoid Mistakes and Limitations with Inherited Retirement Accounts

Individuals who inherit retirement assets may limit withdrawals to required minimum distribution (RMD) amounts and allow the balance to continue to benefit from tax-deferred growth. However, if the intent is to continue tax-deferral treatment, certain steps must be taken to ensure the desired objective is met.

Beneficiaries may stretch distributions from inherited retirement accounts over their life-expectancies or distribute the amount within five-years, when the retirement account owner dies before the required beginning date (RBD)1. The default option under the regulations is stretching distributions over the beneficiary’s life expectancy. However, some IRA custodians and plan trustees choose the five-year option as their default, and some even go as far as to make that the only option. Under the five-year option, distributions are optional until December 31 of the 5th year that follows the year in which the retirement account owner dies, at which time the entire balance must be withdrawn. But, see below for special rules for spouse beneficiaries.

If you have a client who inherits a retirement account from someone who died before the RBD and the client wants to spread distributions over his or her life expectancy, be sure to check the distributions options under the governing account agreement. If the account agreement limit distributions to the five-year rule, it can overridden by transferring the amount to an IRA that allows distributions to be stretched over the beneficiary’s life expectancy. In order for the override to be effective, the transfer may need to be done by December 31 of the year that follows the year in which the retirement account owner dies. If the client misses this deadline, he or she might not be allowed to stretch distributions beyond five-years.

Example:Jim inherited his 55 year-old uncle’s 401(k) account in 2011. Under the terms of the 401(k) plan document, Jim must distribute the amount under the five-year rule. Under the five-year rule, distributions are optional until December 31, 2016, at which time the entire balance must be withdrawn. However, Jim wants to stretch distributions over his life-expectancy. Jim must rollover the amount to an Inherited IRA that allows him to stretch distributions over his life-expectancy by December 31, 2012. This must be done as a direct-rollover to the Inherited IRA, because a 60-day (indirect) rollover is not allowed for a non-spouse beneficiary. Jim must then take distributions from the Inherited IRA over his life-expectancy.

Avoid Harmful Distributions and Transfers

One of the most harmful mistakes made with inherited retirement accounts occurs when amounts are processed as distributions or withdrawals instead of transfers, or when amounts are transferred to the beneficiaries ‘own’ IRAs instead of Inherited IRAs. To help prevent such mistakes, the transfer should be initiated by the receiving financial institution.

Unless your client is the surviving spouse of the decedent, any amount that is withdrawn from an inherited retirement account cannot be rolled over to another retirement account. Therefore, if the intent is to continue maintaining the amount in a retirement account, steps must be taken to ensure that any movement of assets from the decedent’s account to an Inherited IRA is done as a trustee-to-trustee transfer. In addition, the assets must be transferred to an Inherited IRA that is properly registered in the name of the decedent as well as the name of the beneficiary; clearly showing which of the two is the decedent and who is the beneficiary, and using the beneficiary’s social security number.

Caution: When helping clients to move inherited assets from a qualified plan, such as a pension or 401(k), a 403(b) or a governmental 457(b) plan, ensure that any RMD that is due for the year is withdrawn first, and then rollover the balance. RMD amounts are not rollover eligible and must be withdrawn before the rollover is initiated.

Special Provisions for Spouse Beneficiaries

If your client is the surviving spouse of the decedent, he or she can roll over distributions taken from the inherited account, as long as the amount rolled over does not include any RMDs. In such cases, the rollover must be made to the client’s ‘own’ IRA. If your client prefers to keep the assets in an Inherited IRA, any movement between accounts must be done as a trustee-to-trustee transfer to an Inherited IRA.

Caution: Spouse Choosing Between Inherited and ‘Own’ IRA

Distributions from a retirement account are subject to a 10-percent early distribution penalty, unless the account owner qualifies for an exception. One exception is if the distribution is made from an inherited retirement account. If your client inherits a retirement account from his or her spouse while he or she is under age 59½, and plans to make withdrawals from the amount before reaching age 59½, keeping the assets in an Inherited IRA will ensure that the withdrawn amount is not subject to the 10-percent early distribution penalty. The amount can then be rolled over or transferred to your client’s own IRA when he or she reaches age 59½, or will no longer be taking early distributions, if earlier.

How You Can Help

The financial benefits of an inherited retirement account can be severely diminished because of mistakes, all of which can be avoided if the proper steps are taken. Encourage clients to contact you before initiating any transfers or rollovers from inherited accounts. Also, ensure that the transaction is initiated on your end, so that you can help to ensure that a trustee-to-trustee transfer or direct rollover is used when necessary.

1 The RBD is April 1 of the year that follows the year in which the account owner reaches age 70½. If the assets are held in a qualified retirement plan, such as a pension, profit sharing or 401(k) plan, a 403(b) plan, or a governmental 457(b) plan, the employer can allow the RBD to be deferred past age 70½ until April 1 of the year that follows the year in which the account owner retires.

 

II. Help Your Clients Avoid Beneficiary Disasters

With retirement assets totaling $18.2 trillion1, many of your clients will be leaving significant amounts to their beneficiaries. Unfortunately, some of these accounts will be inherited by parties other than those intended by your clients, unless you help them put effective beneficiary designations in place. Here we look at some beneficiary designation mistakes and how they can be prevented.

An Account Statement is not a Valid Beneficiary Confirmation

A few years ago, The New York Post published an article about a couple who had been married for almost 20 years. The husband (Bruce) was unintentionally disinherited from his wife’s (Anne) $900,000 retirement account when she died suddenly from a heart attack. The couple mistakenly believed that the annual statement from the plan administrator, which indicated that there was “no named beneficiary”, was correct. This would mean that Bruce would be the beneficiary by default, so the couple felt it was not necessary to submit new beneficiary forms.

After Anne died, the plan administrator found a beneficiary form that she had completed before she met Bruce, which named her mother, uncle and sister as her beneficiaries. According to the article, Anne’s sister, who, at the time of Anne’s death, was the only surviving beneficiary of the three named, was determined to be the sole beneficiary by the terms of the account agreement. The article goes on to say that Anne’s sister refused to give Bruce any of the funds. The matter was referred to the Supreme Court of New York, which upheld the decision of the plan administrator to treat Anne’s sister as the beneficiary, because her sister was named as beneficiary. This could have been prevented if the beneficiary form had been checked and updated at least once per year.

Divorce Does Not Always Change a Beneficiary

It is a common misconception that divorce revokes a beneficiary designation, where the former spouse is the named beneficiary.

However, there are numerous cases of former spouses inheriting retirement assets, because the deceased retirement account owner failed to complete new beneficiary forms after the divorce. The fact is, whether divorce revokes a former spouse as beneficiary depends on the type of retirement and, in some cases, state law.

For IRAs, some state laws provide that a divorce revokes a beneficiary designation, where the former spouse was named as the beneficiary. For qualified plans, the terms of the plan document determines whether divorce automatically revokes the beneficiary designation. To avoid any confusion, a new beneficiary form should be completed after a divorce. Even if a retirement account owner wants a former spouse to remain as beneficiary, we recommend completing a new form to make sure that the intent is clear.

Document Language May Override Beneficiary Designation

The language used in agreements for IRAs and other retirement accounts can override a beneficiary designation provided by the account owner. For instance, a designation naming someone other than (or in addition to) the account owner’s spouse as primary beneficiary could be overridden by terms of the account agreement.This is often the case for qualified plans and for IRAs when the IRA owner lives in a community or marital property state. In such cases, an exception applies if the spouse provides written consent for someone else to be a primary beneficiary of the account. The spousal consent may need to be witnessed by a notary public or plan representative.

Wills Cannot Be Used As Beneficiary Designations

A common mistake made by many retirement account owners is to update their wills to reflect changes to the beneficiary designations for their retirement accounts. However, this is an ineffective way to make such changes as the beneficiary form on file with the IRA custodian or retirement plan administrator overrides a will. In the event there is no beneficiary form on file, of if the beneficiary predeceases the retirement account owner, then the terms of the governing agreement determines who inherits the retirement account.

What You Can Do

There are several things you can do to prevent something like this from happening to your clients. This include, but is not limited to reviewing beneficiary forms as part of the annual checkup process for your clients, so as to ensure that any needed changes are made in a timely manner. These should be checked and updated again when there is a life-changing event that could necessitate a change in beneficiary designation, such as a marriage, divorce, death of a beneficiary, and/or a new child added to the family.

Helping Your Clients

Ensuring that the right beneficiary is on record is only one of the many steps that should be taken to ensure that your clients’ beneficiary designations meet their distribution and estate planning needs. The end result would not only determine who inherits their retirement account, but could also affect the amount of income and estate taxes paid on the assets, as well as the distribution and estate planning options available to their beneficiaries. You can help your clients by reviewing these agreements, so as to ensure that they are consistent with your clients’ objectives.

1 ICI U.S. Total Retirement Report—2nd QTR 2011

 

See Denise’s must-have, handy tools for retirement professionals at our Retirement Resource Center.

With over fourteen years of experience in the IRA and defined contribution plans fields, Denise held several senior retirement plans related positions with Pershing LLC, which includes Vice President of Retirement Plans Products and Services, Retirement Plans Manager, Trainer, Training Manager, Compliance Consultant, Technical Help Desk Manager and Writer.

Denise’s wealth of knowledge in retirement plans led to her making appearances on CNBC’s Business News and being quoted in the Wall Street Journal, Investor’s Business Daily, CBS Marketwatch’s Retirement Weekly and other financial publications, where she gave insights on retirement planning. Her expertise and knack of explaining complex retirement plans rules and regulation, so that they are easily understood, created a demand for her to speak at various conferences and seminars around the country.

Denise has extensive experience with training the staff and financial advisors of many broker-dealer on retirement plans related topics. With her experience, interests and qualifications dedicated to retirement plans, Denise has written over two hundred articles for many newsletters, including the Pershing LLCs SixtySomething, Pershing LLC’s “The Pershing Press”, Ed Slott’s IRA Advisor and www.Investopedia.com

Denise is also an editor, providing technical editing services for books, newsletters , articles and other material on retirement plans and retirement planning. Books edited by Denise includes Quick Reference to IRAs by Gary lesser and Don Levy-2003; SIMPLE, SEP and SARSEP Answer Book by Gary Lesser and Susan Diehl Ninth Edition, “Parlay Your IRA Into a Family Fortune” (Viking; 2005) by Ed Slott.