Beneficiary audits can help you boost rollover assets

I often am asked to share strategies that help advisers target the growing individual-retirement-account-rollover market.
I know there is no single strategy or magic bullet that makes an adviser a successful IRA expert; it takes years to cultivate that reputation.
However, a simple and effective way for advisers to increase their IRA rollover business now is to conduct a thorough beneficiary designation review of their clients’ IRAs and retirement plans.
Clients frequently fail to review and keep their beneficiary designation forms up to date. This mistake can be costly and result in unintended beneficiaries’ inheriting a lifetime of retirement savings.
By conducting periodic beneficiary reviews, advisers not only will do their clients a great service, but they also will gather critical information about the client’s retirement accounts. The adviser who can help their clients avoid costly mistakes will have the best chance of winning other client retirement accounts.
According to Boston-based Financial Research Corp., 42% of U.S. wealth is held in retirement-registered accounts, mostly employer-sponsored retirement plans and IRAs. Baby boomers not only are planning for their retirement but also are creating wills, trusts and other sophisticated estate-planning strategies to transfer their wealth to the next generation.
However, most people may not realize that their IRAs and qualified retirement plans — probably the largest part of their estate — are neither subject to probate nor affected by the terms of a person’s will. These assets will pass to the next generation, determined solely by the client’s beneficiary designation form.
Accordingly, the beneficiary designation form is one of your client’s most important estate-planning documents but often is overlooked when creating an estate plan.
Here are some common beneficiary designation mistakes to avoid:
Estate as a beneficiary. I always am amazed by how many clients either intentionally or unintentionally name their estate as the beneficiary of their retirement accounts. Some clients actually will direct their retirement assets to be paid “pursuant to the terms of my will.”
Other clients simply fail to complete their beneficiary designation form or forget to name a new beneficiary after a beneficiary dies. When this happens, the assets usually are paid to the client’s estate by default, which probably is the worst beneficiary for IRAs and retirement plans.
IRAs and qualified retirement plans — assets that normally avoid probate — will become subject to probate when paid to the estate. The probate process can be long, cumbersome and expensive.
Furthermore, theses assets may have to be liquidated and paid to the estate as soon as five years after the client’s death. Although individual beneficiaries can elect to have IRA assets paid over their lifetime, thereby “stretching” their tax liability over many years, estates can’t.
Finally, estates are subject to a much higher income tax rate than individuals. This can result in more money going to the Internal Revenue Service than necessary.
To avoid this mistake, simply make sure your clients have an up-to-date primary and contingent beneficiary designated for all their retirement accounts.
Trust as a beneficiary. I understand that many attorneys like to use trusts to facilitate an effective transfer of wealth and maximize all available gift, estate and generation-skipping tax exemptions. However, there are several dangers to directing retirement assets to be paid to a trust.
First, the IRS generally requires the assets to be paid to the trust within five years after the death of the client. The “stretch” rules generally don’t apply to trusts unless the trust is drafted to be a “look through” trust.
If it is, the IRS permits you to “look through” the trust and stretch the IRA to the trust over the life expectancy of the oldest trust beneficiary. Trusts that fail to be a look-through trust include those with beneficiaries that are not individuals, such as a charity, estate or another trust.
Second, it can be expensive to establish and maintain these trusts. If an IRA is stretched to a look-through trust, a lifetime of legal, trustee and administrative fees can significantly reduce the amount the ultimate beneficiaries will receive.
Third, trusts become subject to the 35% tax rate (currently the highest) as soon as the income exceeds $10,450. By comparison, individuals don’t reach the 35% tax rate until their income exceeds $349,700.
That means that if the IRA is worth more than $10,450, more than a third can be lost to the IRS. Unless there is a compelling reason to name a trust as the beneficiary of an IRA or retirement plan, you should help your clients avoid making this mistake.
Ex-spouse as a beneficiary. Few people really intend to leave IRA and retirement assets to an ex-spouse, but this happens all the time.
People fail to update their beneficiary designation form after a divorce. Many times, they are under the mistaken belief that the divorce decree will negate their prior beneficiary designations.
It doesn’t. Divorce decrees, court orders and wills generally have no effect on a beneficiary designation.
When I was in private practice, I had a client who learned that her father had failed to update his beneficiary form after divorcing his second wife. My client, as you can imagine, wasn’t too happy when she realized that her ex-stepmother, instead of her, inherited nearly half a million dollars because of a seemingly simple mistake.
I had another client who failed to change her beneficiary designation after getting married. She died after more than 20 years of marriage, but her IRA initially went to her brother instead of her husband because of an old beneficiary designation.
Fortunately, her brother “disclaimed” his inheritance, and her husband did receive the IRA. But the lesson learned is that all clients need to conduct a beneficiary audit when there has been any major life event, such as a birth or death in the family, a marriage or, most importantly, a divorce.
Per stirpes or per capita. IRA and retirement plan assets aren’t always distributed as intended. Most IRAs will allow the owner to designate multiple beneficiaries.
For instance, it is common for an IRA owner to designate their children as equal beneficiaries. If one beneficiary predeceases the owner or
“disclaims” the inheritance, the remaining primary beneficiaries — and not the children of that deceased or disclaiming beneficiary — will typically receive the balance of the IRA.
This surprises many people. For instance, let’s assume that Dad has an IRA he wants to leave to his two children, Sue and Tom.
Sue and Tom have children of their own. If Tom were to die before Dad, Sue would inherit Tom’s share, and nothing would go to Tom’s children.
This is called a “per capita” distribution. If Dad wants to make sure Tom’s share will benefit Tom’s family, Dad should make a “per stirpes” designation.
This means Tom’s half will be shared equally by Tom’s children.
By conducting a review of your clients’ IRAs and retirement plans, you can help them avoid some costly mistakes, ensure that the right beneficiaries inherit these hard-earned assets, obtain important information about all your clients’ retirement accounts and, as a result, increase your IRA rollover assets.
Brandon Buckingham is director of qualified plans at John Hancock Financial Services Inc. in Boston.

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