Your IRA Beneficiary Dies Before You - What Happens To The Account?

(MENAFN- Free Financial Advisor) An outdated IRA beneficiary designation can send retirement savings somewhere the account owner never intended. Reviewing primary and contingent beneficiaries, along with per stirpes instructions, helps keep inheritance plans aligned with family wishes – Shutterstock

Naming someone as your IRA beneficiary feels like a decision you can make once and forget. Unfortunately, families rarely follow the neat little timeline people have in mind. A child might die years before a parent. A spouse might outlive one beneficiary but not another. Suddenly, the person listed on an IRA beneficiary form no longer exists to collect the money.

So who gets the account?

If your named IRA beneficiary dies before you, that person's share generally does not automatically pass to their spouse, children, or estate. The account remains yours, but the beneficiary designation may no longer work as intended. Your contingent beneficiaries, account agreement, and applicable state law can determine what happens next.

This situation can create an awkward estate-planning problem. The person who inherits your retirement savings might not be the person you would choose today.

Your IRA Doesn't Automatically Follow Your Deceased Beneficiary's Family

Start with one basic distinction: an IRA beneficiary designation identifies who receives the account after the owner dies. It does not give that person present ownership of the retirement savings. Suppose a parent names an adult daughter to inherit a $300,000 IRA. Several years later, the daughter dies, but the parent remains alive. The daughter cannot simply pass that expected inheritance through her will. She never owned the IRA in the first place.

The parent still controls the account and can change its beneficiary designation. However, the original paperwork may no longer reflect the parent's wishes. If the parent takes no action, the IRA custodian must follow the applicable beneficiary provisions in its account documents.

That could mean another named beneficiary receives the money. If nobody qualifies under the designation, the account agreement may direct the proceeds to the owner's estate. The precise result depends on the account's terms and applicable law.

There is one particularly easy mistake here: assuming the deceased beneficiary's children automatically inherit their parent's share. They might, but that outcome requires the appropriate designation or other applicable legal provision.

Per Stirpes Can Keep the Money in the Family

One phrase on a beneficiary form can change the entire outcome: per stirpes.

This designation generally allows a deceased beneficiary's descendants to inherit that person's share. If a parent names two children as equal IRA beneficiaries, for example, each child receives half. If one child dies first and the parent has selected per stirpes, that child's share can pass to their children.

Without that provision, the surviving child might receive the entire account, depending on the custodian's rules. The deceased child's children could receive nothing from that particular IRA. It might sound harsh, especially if the parent intended to treat both family branches equally. Yet beneficiary forms follow their written instructions, not the family's informal understanding of fairness.

Financial institutions don't all handle these designations identically. Schwab, for example, offers per stirpes and per capita options under its designated beneficiary agreement. Its agreement also explains how it distributes a deceased beneficiary's share.

Per stirpes also has limits. The definition can vary among financial institutions and state laws. Some arrangements extend a deceased beneficiary's share to descendants, while others follow different distribution instructions. Never assume that writing a phrase into a will automatically creates the same result for an IRA.

Contingent Beneficiaries Are Your Backup Plan

A contingent beneficiary is essentially the person waiting in the wings. This person receives the IRA if the primary beneficiaries cannot inherit under the account's designation. Suppose someone names two adult children as primary beneficiaries and a grandchild as the contingent beneficiary. If one child dies first, the surviving child may receive the deceased child's share. The grandchild does not necessarily step into the parent's position. That depends on the per stirpes provision and the custodian's rules.

Now consider a different situation. Both primary beneficiaries die before the account owner. The contingent beneficiary may then receive the IRA, assuming that person survives the owner and meets the designation requirements. Without a valid backup, the account agreement determines the next destination.

That destination might be the owner's estate. This creates additional paperwork and potentially brings probate into the picture. The account could also follow a custodian's default beneficiary hierarchy, which may prioritize a surviving spouse or children.

A will does not automatically fix an outdated IRA designation. Retirement accounts generally pass according to their beneficiary forms and governing account agreements. A carefully written will cannot simply override a conflicting designation.

Don't Confuse a Beneficiary Who Dies Before You With One Who Dies After You

There is another wrinkle, and it involves timing.

If your beneficiary dies while you remain alive, the account's beneficiary designation determines who eventually inherits. But suppose you die first, your named beneficiary inherits the IRA, and that beneficiary dies several years later. The rules change because the beneficiary already acquired an inherited retirement account.

The deceased beneficiary's own beneficiaries generally become successor beneficiaries. They must follow the applicable inherited IRA distribution rules. Under current IRS guidance, successor beneficiaries generally cannot restart the original beneficiary's payout period simply because they inherited the remaining balance.

In general, the remaining interest must leave the account within 10 years after the beneficiary's death, or within certain circumstances within 10 years after the original owner's death. The applicable deadline depends on the original beneficiary's status and the circumstances. This can catch families off guard. A grandchild inheriting directly through a per stirpes designation may face different distribution rules from a grandchild inheriting later through a parent who already received the IRA.

The IRS also has special provisions for eligible designated beneficiaries, including certain surviving spouses, minor children, disabled individuals, chronically ill individuals, and people no more than 10 years younger than the original owner. Those categories can affect distribution schedules.

In other words, the family relationship alone does not determine the tax treatment. The inheritance path matters, too.

The Beneficiary Form Needs a Fresh Look

The easiest way to avoid confusion is to review your IRA beneficiary designations after a major family change. A death in the family is an obvious reason, but marriages, divorces, births, and estrangements can also change your intentions.

Ask your IRA custodian for the current beneficiary information. Check whether the deceased person still appears as a primary beneficiary. Then examine the percentages, contingent beneficiaries, and any per stirpes or per capita instructions.

Don't stop at the online account summary, either. Request the actual beneficiary designation on file and read the applicable account agreement. If the language confuses you, ask the custodian to explain how it handles a beneficiary who dies before the account owner. For complicated family arrangements, an estate-planning attorney can help coordinate the IRA designation with your will or trust. A tax professional can also explain the potential consequences of different inheritance arrangements.

The IRS publishes its current distribution guidance in Publication 590-B. It covers inherited IRA rules, required minimum distributions, and successor beneficiaries. An IRA beneficiary form might occupy just one page. Its consequences can reach several generations. A few minutes spent reviewing it could prevent years of family confusion over money that someone intended to leave behind.

If one of your named IRA beneficiaries died before you, would you know who receives that person's share? Or is it time to dig out that beneficiary form?

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