The assets in any IRA you hold will be disbursed to its named beneficiaries, if any, or according to the account custodian’s policy. In order to ensure your IRA is distributed according to your wishes, it is important to keep your IRA beneficiary designations up to date. You should review your IRA account’s beneficiaries anytime you go over your will, after a marriage, birth, death or divorce, as this article will discuss.
Your IRA beneficiary designations should certainly be reviewed after a divorce, lest the account be distributed differently from how you would prefer. You may have:
- named your former spouse as a beneficiary
- not filled out or forgot to submit the beneficiary form
- moved since divorcing to a community property state
In the above examples, your ex-spouse may have a claim on your IRA upon your death. Filling out an amended beneficiary form is easy and will ensure your IRA assets are distributed according to your wishes.
This guide is intended to help you ensure your IRA assets will be given to the people you love and the organizations you care about. First, we will look at the laws governing how IRAs are distributed to heirs. Second, the possible IRA beneficiary designations will be explained. We will close by defining a couple of important terms.
Laws Governing IRA Distributions to Heirs
The distribution of a deceased person’s IRA is governed by each state’s laws, but there are two general patterns. Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wyoming are all community property states. In order to leave an IRA to anyone but their spouse, residents of these states need to have written, notarized permission from him or her. In some cases, an explicit statement is even required from ex-spouses: One Texas woman’s ex-husband was awarded her IRA upon her death, despite divorce documents that stated otherwise (Holmes v. Kent, 221 S.W.3d 622 (Tex. 2007)). Alaska has adopted a community property system, but it is optional.
In the other non-community property states, including Georgia, you do not need permission from your spouse to name someone else as the beneficiary of your IRA. You do need to name someone, though. Otherwise, your account will be distributed according to its custodian policy, which might give it to your ex-spouse or your estate. Both outcomes are less than desirable
Possible IRA Beneficiary Designations
Any person or organization can be designated as your IRA’s beneficiary. Family, friends, estates, trusts and charities are all commonly used designations. Charities provide their own tax advantages, but these are not related to divorces. Thus, we will focus on the other options.
Estates: Tax Disadvantage
Simply letting your IRA go to your estate has a significant tax disadvantage. Non-spousal disbursements cannot be drawn out over a long period of time (commonly referred to as a “stretch” IRA), so your heirs will not be able to capitalize on the account’s full tax deferral benefits over the remainder of their lifetime. Traditional IRAs of people who pass away before the age of 70 ½ must be fully withdrawn within five years to avoid penalties. Traditional IRAs of people over 70 ½ (the age of mandatory withdrawals) must be withdrawn according to the deceased owner’s life expectancy or your own life expectancy.
There are some additional considerations for distributing Roth IRAs which are beyond the scope of this article.
Trusts: Advantages, with Complexity
Trusts have several benefits, but they can be complex. Many divorcees, especially those with young children, decide to name a trust as their IRA’s beneficiary, because through a trust you can:
- control the time over which heirs receive the assets in the trust
- prevent creditors, including ex-spouses, from accessing the funds
- state how you would like the funds used by trust beneficiaries (to a degree)
Trusts that qualify as designated IRA beneficiaries also let heirs withdraw the account’s assets over a longer period of time, extending the tax deferral benefits of your IRA. In order to meet all of the IRS requirements for a trust to serve as a designated beneficiary, you should seek professional assistance from a qualified attorney.
People: Family and Friends
Naming individuals like your children as the beneficiary of an IRA is simple. The institution holding your account will have a form to amend the beneficiaries of the account. Fill it in with the appropriate names and proportions, and you are all set. As long as you are comfortable with the beneficiaries spending the funds as they see fit upon receiving them, this is the easiest and most straightforward option.
Whenever you name people as IRA beneficiaries, you should also name contingent beneficiaries. Any contingent beneficiaries would become your heirs, should a primary beneficiary predecease you. As with primary beneficiaries, contingent ones can be anyone you would like. There are two terms used to forward a predeceased primary beneficiary’s share to their descendents, which is most people’s wish.
Per-Stirpes: Should a primary beneficiary predecease you, a per-stirpes designation would pass along the primary beneficiary’s portion of the IRA to their surviving heirs, usually their children.
Per-Capita: Per-capita also passes a predeceased beneficiary’s share to their heirs, but it divides the predeceased beneficiary’s share equally among all beneficiaries.
As an example, consider Mary. She has an IRA with two beneficiaries, Mark and Jennifer, who will each receive 50 percent of the account. Mark and Jennifer each have two children. Let’s assume Mark predeceased Mary. Here is how the account would be distributed upon Mary’s death:
- With no designations, Jennifer would receive everything, but would have to go through probate
- With a per-stripes designation, Jennifer would receive her share and Mark’s two children would receive his
- With a per-capita designation, Jennifer would receive everything and Mark’s two children wouldn’t receive anything
Most IRA account beneficiary forms use per-capita as the default selection.
Update Your Beneficiaries
If you have not updated your IRA beneficiary designations since a divorce, you need to address this as soon as you can. And if you’ve experienced any other changes to your family or personal situation, it would be wise to review your beneficiary designations as well. You can call the institution maintaining your IRA for a form or ask your financial professional for assistance. It is the only way to ensure your wishes will definitely be followed in the manner you desire.
And be sure to review and update other beneficiary designations including life insurance, Roth IRAs, and employer retirement plans like 401ks.