Common mistakes with retirement account beneficiary designations
Learn how to avoid easily overlooked pitfalls when making charitable gifts of retirement assets
July 16, 2020 | by Tia Barnes J.D.’03
Naming a public charity as the beneficiary of your retirement account can be a wonderful and tax-efficient way to make a legacy gift to the organizations that are important to you. It is relatively simple to make a gift using the beneficiary designation form provided by the financial institution that serves as the retirement plan administrator or custodian. However, donors may encounter some common mistakes with charitable beneficiary designations. In this article, we explain those pitfalls and aim to help you avoid some unintended consequences.
NAMING INCORRECT OR UNIDENTIFIABLE BENEFICIARIES
The charity named on the form should match exactly the name of the intended organization. Just as family members can have similar names – like a mother and daughter who share the same first and last name but have different middle names – charitable organizations can also have names similar to one another. For example, a search of the terms “children’s hospital foundation” will yield multiple similarly named organizations. If, after your death, there is any confusion about which charity you wish to receive the assets from your account, your retirement plan administrator may choose the wrong organization.
You can take two important steps to avoid confusion:
Let the charity know that the gift is coming! The organization may have a form, such as Duke’s confirmation of legacy gift form, with which you can declare your non-binding intention to make the gift. This is important because the plan administrator is not obligated to notify the charity when the assets become available. When you notify the charity, it allows the organization to recognize you for the gift during your lifetime and positions the charity to follow up with your plan administrator after your death.
Ask the charity for their legal name, address, and tax identification number so that you can include this information on the beneficiary designation form. This will help ensure that the proper organization benefits from your gift.
DESIGNATING A SPECIFIC DOLLAR AMOUNT INSTEAD OF A PERCENTAGE
Some donors like to ensure that a charitable organization will receive a specific amount. To accomplish this, they may make a designation that reads something like, “$100,000 to Duke and the remainder to my niece, Patrice.” This designation may not be an issue for accounts with balances significantly higher than the stated amount. However, it could be problematic for accounts with a balance closer to the amount of the designation.
In the example above, if the account takes a loss on investments or makes distributions to meet the required minimum distribution, then the balance at the time of the donor’s death could be less than $100,000. The plan administrator may interpret the designation in a way that eliminates the charitable organization, since the amount does not meet the donor’s exact specifications, and give Patrice the full balance. If the donor wanted Duke to receive at least some of the assets, then the gift is unsuccessful.
A more effective beneficiary designation is one that awards each beneficiary a percentage of the assets. If the account does very well, the beneficiaries share in the increased value. Alternatively, if there are losses, the beneficiaries receive less in a proportionate manner.
But if your intention truly is to leave to a beneficiary a specific dollar amount, rather than a percentage, we suggest that you contact your plan administrator to discuss how to effectuate this successfully. It may require special written instructions from you to be kept on file by the administrator.
OMITTING SPOUSAL CONSENT
Employer-sponsored retirement plans, such as pension plans, profit-sharing plans, 401(k)s, ESOPs, Keogh plans, and 403(b)s, are usually subject to federal spousal rights. Spouses may also have rights under state law in community or marital property states. Based on these rules, the spouse may be automatically entitled to 50 percent or 100 percent of the retirement account on the death of the participant, regardless of what the beneficiary designation says.
To protect the spouse’s interest as the primary beneficiary, the law requires the participant to seek the spouse’s written consent for any other beneficiary designation. This requirement may even apply when the participant only wants to leave a portion of their account to someone other than a spouse. If the participant does not get consent from their spouse, then the plan administrator may not honor the beneficiary designation.
A donor should seek advice from her financial or legal advisor or the retirement plan administrator to determine whether a spousal waiver is required.
NAMING YOUR ESTATE AS THE BENEFICIARY OF YOUR RETIREMENT ACCOUNT
Some donors may be inclined to designate their estate or living trust as the beneficiary of their retirement account and, in turn, make bequests to individuals and charities from the estate. There may be tax implications for taking this approach with a charitable gift.
If your estate is the beneficiary of your traditional retirement account, then the estate will likely pay income tax on those assets. After the assets become part of the estate, they become subject to estate expenses including creditors, final bills, and probate fees. The estate will distribute to individuals and charities after all other matters are settled and the distribution may be significantly less than the donor intended.
A gift made directly to a charitable organization using the plan administrator’s beneficiary designation form circumvents the donor’s estate and comes directly to the organization in full and likely sooner than if the gift came through the estate.
A charitable gift of retirement assets may be a great way to make a legacy gift that will continue to support the causes that are important to you beyond your lifetime. Duke’s Office of Gift Planning encourages you to discuss this option with your legal and financial advisors as a part of your complete estate plan to determine what is appropriate for your individual situation.