We spend our lives accumulating wealth and fulfilling the wishes of our loved ones. Apart from this, we plan for our retirement as well such as funding our retirement accounts like IRAs, 401(k)s, 403(b)s, etc. However, while starting these accounts we need to ensure that we have properly designated a beneficiary who would get the money if in case of our death. Failing to do so can result in our accounts facing probate for the distribution to the heirs. However, by properly updating the beneficiary designation one can avoid probate and thus such accounts can bypass the probate
When a person opens a retirement account, naming beneficiaries is among the paperwork required to do so, which can be a single person or multiple people according to the person’s wishes. One is said to be the indirect owner of the retirement accounts, however, there is a third party owner like a custodian who takes care of the assets for the benefit of the owner and hands over the assets to the named beneficiaries after your death. Apart from the benefit of avoiding probate, these accounts also help in securing the wealth from creditors.
A valid beneficiary means someone who is alive, can receive the assets and meets any requirements set by the administrator of the asset. By not meeting any of the aforementioned criteria, the beneficiary designated is not considered as valid and thus probate will come into the picture to distribute the wealth causing delays, reducing the amount received by the beneficiaries, and limiting payout options.
Why retirement accounts go through probate?
Here we have summarized some of such instances that lead you to inviting probate:
Not naming your spouse: In most of the states, it is mandatory that a spouse is entitled to half of each and everything that has been added to the retirement account during the marriage by the other spouse. This implies that in case you have named someone other than the spouse, completely or partially, as your beneficiary for such accounts then the spouse is authorized to file a claim to the assets which will invite probate. Hence, you must have a signed waiver by your spouse if you are designated a beneficiary other than your him/her.
If you name your estate or trust as beneficiary: Naming your estate a beneficiary to your retirement account can cause you loss of money and time as the estate will have to go through probate and thus the creditors can claim their debts reducing the amount. In the same way, designating a trust as the beneficiary is not suggested as the beneficiaries lose some funds as well as the flexibility to use the funds. If in case, you want a trust to handle the funds for some time in case of spendthrift or minor beneficiary then you must discuss with a lawyer first.
Naming a minor as beneficiary: Minors are not authorized to inherit the funds of the retirement accounts directly. If you are willing to name a minor as the beneficiary, then in order to avoid probate, you should designate someone who will manage the funds until the minors become adults. You can consider using the Uniform Transfer to Minors Act (UTMA) to name a custodian for your account. In case of failing to do so, the court might need to step in to do it for you.
Not naming alternate beneficiaries: It is always advised to name alternate beneficiaries for your retirement accounts to protect your accounts from probate. As in the case, your designated primary beneficiary is dead or is unable to receive the funds due to other reasons like mental incapacity, etc., probate will step in to distribute the funds. This can easily be avoided by having alternate beneficiaries to receive the funds in the absence of primary beneficiaries.
Keeping beneficiary designations up-to-date: You can change your beneficiary designated anytime according to your wishes for which you need to contact the account administrator to update the beneficiary information. It could be done in case life-changing events like the death of the beneficiary, divorce, remarriage, childbirth, etc. In case you die after the death of your beneficiary then the probate will step in and distribute the money. In case you die with your ex-spouse as the beneficiary, then even after your remarriage, your ex-spouse will have claims on the funds of such accounts. Hence, to avoid any such circumstances, it is advised to review your accounts and if required, update the beneficiaries as well.
Retirement accounts can be used to transfer the funds to your heirs without the intervention of the probate and creditors, however, you need to avoid the aforementioned mistakes while naming beneficiaries for these accounts. Designating a beneficiary is usually just a matter of filling out a simple form, and you may even be able to do it online while reviewing them with due course of time, at least annually or with life-changing events like divorce, remarriage, etc.