Estate planning: three common IRA beneficiary form mistakes to avoid

Individual retirement accounts (IRA) are the single most important assets for many retirees that are meant to supplement the retiree’s income in his or her lifetime and provide funds for their loved ones once they die. Yet, despite the importance of these accounts, IRA owners are often guilty of committing costly errors when filling their IRA forms, which leaves their heirs out in the cold.

Here are the three of the most common IRA beneficiary form mistakes to avoid if you want to prevent high taxes on your retiree income and ensure your heirs get their rightful inheritance.

1. Not naming an actual persons as your beneficiary

One of the most common IRA beneficiary form mistakes to avoid is not naming an actual person as your IRA beneficiary or leaving the beneficiary form blank. When you leave the IRA beneficiary form black and you don’t name an actual person as your beneficiary, it limits your heirs’ ability to "stretch" the IRA over the next generation after your death and hinders them from getting maximum tax deferral.

In addition, not naming a beneficiary forces the probate court to consider your asset still yours even in death, which makes the asset subject to creditors and liable to income taxes on its distributions. Income taxes on distributions can quickly accumulate to thousands of lost growth potential. Do your family a favor and name an actual person as your IRA beneficiary. Don't leave your IRA form blank.

2. Forgetting to update your beneficiary form

Another common IRA form mistake is forgetting to update the form after divorce, remarrying or death of the person initially designated as the IRA beneficiary. The IRA beneficiary form overrides your will. If you forget to update your IRA beneficiary form after you get remarried, it won’t matter whether you changed your will or not.

The person named as the beneficiary on your IRA form will legally be entitled to your assets upon your death. In most cases, this means your ex will be the legally beneficiary and he or she can pass along your asset to any children he or she may have from their other marriage(s).

Always update your IRA form as soon as possible whenever there is a significant change in your life, such as adivorce or remarriage. This can help prevent many problems, arising from your estate distribution.

3. Overlooking IRA tax implications

Yet another common IRA beneficiary form mistakes to avoid is overlooking tax implications from inherited IRA. Usually, distributions up to a certain limit from a person’s estate are received tax-free. However, distributions from an inherited IRA are classified under a tax code called income in respect of a decedent (IED). IED distributions are subject to regular income tax imposed on the IRA beneficiary.

While determining the likely inherited IRA tax deductions imposed on your beneficiaries can be complicated, it is important for proper estate planning to take care of these deductions as best you can. You can find details of what to do in this regard in the IRS Publication 3920 at irs.gov/instructions/i1041/ch01.html#d0e311.

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