I think that few financial advisors discuss this with their clients or even understand some of these issues. The custodian that holds your IRA (bank, securities firm, insurance company) may have rules that do not agree with your desires for distributing your IRA. And their rules rule.
Figure 4: Beneficiary Designation Issues
Let’s consider some examples.
Here’s an example of how the beneficiary designation form provided to you by your custodian. Let’s say you have two sons, Jack and Tom. You know those beneficiary forms they give you when you open a retirement account? The first line asks for your primary beneficiaries. And you list Jack and Tom. Jack and Tom each have a son. Jack’s son is Bob. Tom’s son is Dan. The next line on the form usually says contingent beneficiaries or secondary beneficiaries. And you name Bob and Dan as the secondary beneficiaries. Here’s my question to you. If Jack dies before you do, what happens to Jack’s half of your IRA when you pass away?
You might think that Jack’s share would go to his son Bob. Not always. Because on your beneficiary form there may not be a place to specify that Bob is Jack’s son. I’ll tell you the solution in a second. But what I want to point out to you is that some of these beneficiary forms can sometimes be deficient in terms of carrying out your wishes. And this is a very simple example, right? Two sons, two grandsons. Unfortunately, what you want to happen in the above example might not happen.
Every custodian has a policy in the case above. They will either make the distribution “per stirpes” (to your son’s decedents) or “per capita” (to the other primary beneficiaries). Therefore, you must know the policy of your custodian on this issue. Alternatively, you may just decide to write the custodian a note about your desires. Don’t do that and assume they will read it or follow it. The only way to be sure that the custodian follows your desires is through an IRA Asset Will or by making your beneficiary a trust.
An IRA Asset Will is a document that an attorney draws to replace the one page form that many custodians have. This custom document explains how you desire your IRA to be distributed. However, the custodian is under no obligation to take your IRA asset will. They could tell you “here’s OUR form, take it or leave it.” And of course, since this is America, the land of choice, you can take your IRA to another custodian.