When it comes to IRAs, you better make sure you know exactly who gets to keep your money after you pass.
They say you never want to leave this earth with any regrets. Financial advisors and lawyers say you better read the fine print before you depart or it could cost your heirs.
That’s the situation of a case of Leonard George Smith, a North Carolina man who had two IRAs totaling $400,000. He had listed his children as beneficiaries, only to make changes on the forms for the proceeds to be distributed according to his will. He died of cancer in 2008.
The will designated his children, two daughters and a son, as the beneficiaries, but the problem is the IRA forms weren’t filled out correctly. The money instead went by default to his new wife of only a couple of months even though that wasn’t his intention. The couple had been together for about five years, and he had only left her $100,000 in his will and he left the rest to his children.
That’s the ruling that came from the North Carolina Court of Appeals, which went against Smith’s wishes and his attempts to leave the money for his children. Smith had owned successful catering companies.
The IRAs required he designate someone to receive the benefits by name, and it didn’t allow what is called cross-referencing the will.
That should be a lesson to all of us to make sure of the rules of financial instruments and beneficiaries we list in them. They can override wills.
Financial planners say the reason for that is that using beneficiary forms makes the process of distributing the funds much easier (and quicker) rather than go through probate. No one wants to see money already allocated tied up for any length in the court process.
“The beneficiary designations are typically more effective,” says Pat Day, a partner, principal and senior financial planner with the Miami-based The Enrichment Group. “The action of law occurs instantly upon death and the will is something that is read later. In that regard, the beneficiary designations on the IRA application would hold sway. Whatever is in the will would not be very effective.”
The one good point is no one is able to change a will near the end of someone’s life to gain access to the IRA funds. IRAs are the only instruments that involve listing beneficiaries. The others are life insurance policies, bank accounts, stocks, bonds and CDs.
Advisors say there’s no automatic process for updating these forms, and it’s up to people to do the legwork themselves to make sure their heirs get the funds as designated or make sure they work with financial planners to prevent any oversights.
“They’re as important as a beneficiary on a life insurance policy,” Day says. “The act of law is very similar. If you have a life insurance policy that has a death benefit that goes to a particular person it almost doesn’t matter what you say in your will. The law takes effect instantly upon death and it goes to the beneficiary designations and transfers allows the transfer of assets of the owner. It’s the same thing with an IRA and the same thing with an annuity. Those are very important factors.”
Courts have been busy when it comes to IRAs.
The US Supreme Court recently ruled that IRAs aren’t protected from creditors during bankruptcy proceedings.
Like this latest case, the ruling involved heirs who were not the spouse who inherited retirement accounts. Only spouses are protected. The Supreme Court ruling arose from a case involving a Wisconsin couple that owned a pizzeria and filed for bankruptcy in 2010 after shuttering the business. The prime asset of the couple was $300,000 in IRAs that they inherited from the wife’s mother.
The couple owed about $700,000, setting the stage for the lawsuit filed by the trustee administering the estate. What was decided did Congress pass laws in 2005 to protect creditors from taking retirement accounts and whether it included those some protections to those who inherited them.