If Your IRA Names Only Your Spouse and No Backup, the Money Could Land in Probate

Quick Read

• A blank contingent beneficiary line on an IRA can send the money to probate if your spouse dies first, leaving your family waiting for months.

• Estates are not individuals, so an IRA payable to an estate usually must be emptied within five years, while named people often qualify for longer payout periods.

• Check every retirement account, policy, and annuity, and make sure your contingent beneficiaries total 100%.

• Americans who work with a financial advisor have saved more than twice as much for retirement, on average. Find out what one could change for you: SmartAsset's free quiz matches you with up to three vetted fiduciary advisors in about five minutes. (Sponsor)

Many IRA owners name a spouse as the primary beneficiary for the full account value and leave the contingent beneficiary line empty. That unused line deserves a quick review. Without a backup beneficiary, the money could end up in probate if the primary beneficiary dies first.

Your Backup Heir May Be Missing

A contingent beneficiary is the backup heir. That person receives the account if the primary beneficiary dies first or gives up the inheritance, and the beneficiary form usually controls who gets the IRA, typically overriding a will.

The problem arises when no one named on the form is alive. In that case, the custodian follows the default language in the account agreement, and those defaults often point to the estate. In one IRS private letter ruling, the named beneficiary no longer existed when the owner died, so the estate became the beneficiary by default. Money paid to an estate generally goes through probate, the court process that settles a person's affairs, which can mean months of delay, court costs, and legal fees before heirs receive anything.

Most estate complications start with a blank form, an outdated beneficiary, or an account that was never retitled. Our free guide includes the full cleanup checklist: Die With a Plan.

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• 1. How much can you withdraw each year without running out?

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Estates Face Less Favorable Tax Rules Than Individuals

Tax law treats people and estates differently. Under 26 U.S.C. § 401(a)(9)(E)(i), a designated beneficiary is “any individual designated as a beneficiary.” An estate is not an individual. IRS Publication 590-B explains what follows: if the beneficiary is the owner's estate, the five-year rule applies.

That rule requires the full balance to be distributed by December 31 of the year that includes the fifth anniversary of the owner's death. That applies to owners who die before their required beginning date. If the owner dies after that date with no designated beneficiary, payouts are based on the owner's life expectancy.

Named people often have more flexibility. Many can stretch withdrawals under the 10-year rule. Eligible designated beneficiaries include a surviving spouse, the IRA owner's minor child, a disabled or chronically ill person, or someone no more than 10 years younger than the owner. Spreading withdrawals over time can help heirs stay in lower tax brackets.

Who Should Review Their Forms Now

This affects anyone with an IRA, 401(k), life insurance policy, or annuity that names one person and no backup. Married couples are the most common example, since partners often name each other and stop there. The stakes are highest for people nearing retirement: families ages 55 to 69 hold 49.5% of all families' defined contribution retirement wealth, according to Federal Reserve data. If you already named backups and nothing in your life has changed, you are likely covered.

Five Ways to Fill the Blank Line

1. Log in to every account and open the beneficiary page. Each IRA, 401(k), policy, and annuity has its own form, and one does not cover the others.

2. Name one or more contingent beneficiaries and assign percentages that add up to 100%.

3. Choose per stirpes if it is available. That means “by the branch.” If one of your children dies before you, that child's share passes to that child's children instead of being divided among your other children.

4. Update the form after every marriage, divorce, birth, or death.

5. Keep the disclaimer option in mind. A primary beneficiary who does not need the money can refuse it so it passes to the backup. A primary beneficiary generally has nine months after the owner's death to make a qualified disclaimer. September 30 of the following year is the separate deadline for determining which beneficiary counts under the IRA distribution rules. Without a contingent beneficiary, a disclaimer could send the money straight to the estate.

A 401(k) Follows Stricter Spousal Rules

Federal law gives a surviving spouse an automatic claim on most 401(k) plans. Under 26 U.S.C. § 401(a)(11)(B)(iii)(I), the plan must pay the full vested balance to the participant's surviving spouse unless the participant agrees to someone else. That agreement must be in writing and witnessed by a plan representative or a notary public, according to § 417(a)(2). In practice, the spouse remains the primary beneficiary on the 401(k), and the contingent line is where the planning happens.

Missed distribution deadlines can also trigger a penalty. The penalty applies to several groups. Any heir, estate, or person who leaves money in an inherited account past the deadline risks an excise tax equal to 25% of the shortfall under 26 U.S.C. § 4974(a). A compressed five-year window makes that mistake easier to make.

One Task Before the Week Starts

Log in to every retirement account, policy, and annuity you own, and check the contingent beneficiary line. If it is blank, fill it in. It takes only minutes, and it determines whether your money goes directly to your family or waits for a probate judge.

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