Top 5 Mistakes to Avoid in Retirement Account Planning
What happens to your retirement accounts when you die? It can be easy to overlook this simple question. More common conversations about retirement concern these questions: “Will I outlive my assets?” “Am I saving enough?” or “Is my portfolio properly diversified?” Determining where your assets will go after your death is often an afterthought. However, it might be one of the most important decisions you need to make. And, it is entirely up to you!
When it comes to retirement accounts, like a 401(k) or a Roth IRA, you have the ability to name a beneficiary. A beneficiary is a person or entity that you designate to receive the assets in your account upon your death. The benefit of designating a beneficiary is that the custodian will release those assets directly to the person or entity you name. Depending on the situation, this could allow the assets to pass without having to go through probate, which could allow your beneficiaries to receive those assets six to 18 months sooner.
It’s important to watch for common mistakes that could cause your account to be tied up in probate or the court system, because your assets may wind up with someone you don’t intend.
1 – Not Naming a Beneficiary At All
One such circumstance could occur if you do not name a beneficiary. Maybe you overlooked it when you opened your account and didn’t review it again. Maybe you are single and don’t have any living relatives, so you left it blank. Or maybe you’re a parent who can’t decide how to divide the account among your children, so you left it blank. Failure to list a beneficiary typically means a court will distribute your assets based on appropriate state law. This will take time for the courts to decide and an attorney to assist with the process. You should always name a beneficiary because it will save time and money. But more importantly, you have a voice in determining where your hard-earned money goes.
2 – Not Removing an Ex-Spouse
Another common mistake is to not remove your ex-spouse as your beneficiary. Many times in a divorce, retirement assets are split or redistributed, but the account could stay intact. Because the divorce process can be overwhelming and stressful, you might forget to change your beneficiaries after the divorce is final. From a legal perspective, it might not matter that you are legally divorced. The beneficiary you list on the account usually will trump any wills, trusts, or divorce decrees. And because the custodian is required to distribute the assets to the beneficiary listed, the assets would be given to your ex-spouse.
Typically, a spouse is not guaranteed a portion of the retirement account. The account owner has the right to name anyone they would like – except in community property states. In these states, the account holder needs to name their spouse as a beneficiary of at least 50% of the account balance. If the account owner decides not to designate their spouse as a beneficiary, their spouse’s approval is required. Many custodians do not require the spouse to sign off on this, so it would be up to the beneficiaries or surviving spouse to retain documentation of this approval. This can get complicated if there are second marriages or extended families and may cause arguments or even legal action between surviving members of the family.
3 – Failing to Consider a Beneficiary Predeceasing You
One scenario we typically don’t like to think about but is a real possibility: What if your beneficiary dies before you? For example, the account owner has three children in their 50s with children of their own. What happens to the assets if one of the children passes away before the account owner? The answer depends on how the owner listed the beneficiaries on the account. The assets could be distributed to the remaining two beneficiaries, with each surviving child receiving 50% of the account versus one-third. This designation is referred to as “per capita.” Or the deceased beneficiary’s portion could be distributed to their children. This designation is referred to as “per stirpes.” It might be worth reviewing your beneficiary designations to make sure this is set up as you intend.
4 – Assuming a Will or Trust Will Handle Everything
During the retirement planning process, some individuals include estate planning documents, like a will or trust, to determine how their estate will be handled when they die. A common mistake is to assume these documents will take care of everything. With regard to retirement accounts, the person or entity listed as the beneficiary will most likely take precedence over an established trust. Unless you have the trust listed as the beneficiary, this document will most likely not be used to determine the distribution of the retirement account.
5 – Letting Emotions Get in the Way
Finally, a common mistake is allowing your emotions to stop you from making a decision. Maybe you think that if you talk about what will happen when you die, you are inviting death. Or, maybe the thought of your children having to live without you is too much to think about. Perhaps you are afraid of being judged for your decisions by those who survive you. These thoughts and emotions can be overwhelming and could lead you to not make a decision, or make a decision that doesn’t feel right. A trusted financial advisor can help you work through some of these blocks to make sure you are taking the right steps now for the disposition of your assets.
Your retirement assets are going to pass based on the decisions or lack of decisions you make. You are ultimately responsible for how your assets are distributed when you die. If you don’t name a beneficiary, then you have chosen to let the court make the decision for you. If you do name beneficiaries correctly, your voice will be heard and your wishes followed.
One Last Tip: Don’t Just Write It – Talk About It
After your decisions are made and documents are in place, take the next step and have a discussion with your family. It is important for them to hear in your own voice what your wishes are for the assets you leave behind. Talk about your philosophy about money and what you hope they would do with the assets once you are gone. It is your chance to provide a lasting legacy – both through financial resources and unforgettable memories.
Anne M. Mank
Director of Financial Planning