Some time ago, one of our clients—call her Amy—was involved in a legacy issue that occurs after some deaths. Amy and Beth were sisters, but Beth predeceased their mother. The mother died, leaving an IRA to the daughters, 50-50.
The IRA beneficiary form, created decades earlier, did not adequately deal with beneficiary designations. Under the IRA custodian’s rules, all of the money in the account went to Amy; nothing went to Beth’s two children, who were young adults.
Here, the IRA balance was small, so no family issues arose. However, if a six- or seven-figure IRA had been involved, the outcome might have been different: litigation, hard feelings among loved ones, and so on.
Latin Legalities
The Amy-Beth example illustrates a misunderstood area of IRA beneficiary management that can cause significant inheritance problems. Fortunately, there is a simple and effective way to avoid inheritance issues that is overlooked by many: express a choice between a per capita and a per stirpes payout on the IRA beneficiary form.
Per stirpes is a Latin phrase that means “by roots” or “by branch;” per capita is Latin for “by head.” Before drilling down to how these terms apply to current estate planning, it’s vital to keep in mind how widely they might be used.
Beneficiary designations are required for all types of IRAs, all employer-sponsored retirement accounts [401(k)s, 403(b)s, 457(b)s, profit sharing plans, defined benefit plans], annuities, and life insurance policies. For this article, I’ll use ‘IRAs’ to cover all such assets.
Going Straight
For all the relevant assets, proper beneficiary designations are separate from and take precedence over the instructions in a will or a trust. Thus, an IRA passes via direct transfer to named beneficiaries after the account owner’s death, bypassing the time and expense of going through probate.
What’s more, if the IRA beneficiaries are one person or multiple people, naming a direct beneficiary is one of the easiest and lowest-cost estate planning options available. The beneficiaries just deliver a death certificate to the custodian and the account will be distributed without the need for an attorney.
Among married couples, the usual plan is to name the surviving spouse as 100% primary beneficiary and the children as contingent beneficiaries with a preference for per stirpes or per capita IRA distributions. After the first spouse’s death, a new IRA for the surviving spouse would then list the children as primary with a preference for per stirpes or per capita IRA distributions.
Where does this Latin language come into play? The preferred choice becomes crucial if one or more of multiple beneficiaries predeceases the account owner. Per stirpes would distribute the deceased beneficiary’s share to his or her children in equal parts while per capita would distribute the amount in question among the still-living remaining beneficiaries.
Excluded Descendants
In a hypothetical example, suppose Jane was the sole beneficiary of her husband John’s IRA. Jane’s two children (Ken and Kim) are now 50-50 beneficiaries of Jane’s IRAs. Both Ken and Kim are married, and each couple has two children.
Now suppose that Jane and daughter Kim are killed in an auto accident. If the per stirpes designation is in effect, 50% of Jane’s IRA will go to her son Ken and Kim’s 50% share would be divided equally between her two children. Kim’s inheritance would pass via the per stirpes root, branching into equal amounts for her children.
However, if the per capita designation applies, only one of Jane’s named beneficiaries—Ken— would be alive to inherit. Ken would receive 100% of Jane’s IRA and Kim’s children (Jane’s grandchildren) would not receive any of Kim’s 50% share.
Form Fitting
As illustrated, this per stirpes or per capita detail can have serious ramifications, including unwanted post-death distributions, if not addressed properly. Some beneficiary designation forms have boxes to check, for choosing per stirpes or per capita, but other custodians’ forms do not provide the selection opportunity.
Years ago, it was quite common for beneficiary forms to ignore this issue, with no obvious space or box to check in order to provide specific instructions. IRA owners were forced to write “Per Stirpes” or “Per Capita” next to the beneficiary’s name. Unfortunately, many IRA owner were not aware of the possible consequences and therefore did not write in a preference. As a result, the IRA custodian’s default option—buried in the fine print disclosures—applied,
regardless of what the IRA owner might have desired.
Times have changed, though. Most IRA beneficiary forms now have either one or both options listed as a check box next to each beneficiary designation. If only one option has a check box, my experience indicates that it is usually “Per Stirpes.”
Some examples:
- LPL’s Private Trust Company beneficiary form has a check box for both.
- Pershing has one check box for “Per Stirpes.”
- TD Ameritrade’s form also offers only one check box—for Per Stirpes—next to each
beneficiary. - Schwab’s form has an explanation of the designations, a global option selection and then a yes/no check box next to each beneficiary for the global selection.
Regardless of how the IRA custodian structures its beneficiary forms, we have planning reviews with our clients to explain these two choices. To see one possible outcome, a client I’ll call Steve retired about three years ago with an IRA now worth $3 million.
Steve and his wife Teresa have two grown children, a daughter and a son. Their daughter is married, with one child and another on the way; their son is single with no plans to have children. After our explanation, Steve elected to leave this IRA to Teresa as 100% primary and the children as contingent beneficiaries (50% each): the daughter as per stirpes and the son as per capita. This would allow for a streamlined distribution process in the event the son predeceased the IRA owner, and the beneficiary form was not updated in a timely fashion. We have agreed to review this approach and adjust it if the son decides to have children.
IRA owners should review their existing beneficiary forms to see if the beneficiaries are listed as either per stirpes or per capita. If such a designation is omitted, the beneficiaries will be subject to the default option the IRA custodian has in place. In summary, IRA owners should regularly check their beneficiary forms and update them if changes are needed. This will ensure the IRA owners wishes are followed properly after they pass.
An estate attorney or financial advisor can help guide IRA owners through this process.
The material presented is for general information only and not intended to provide specific advice for any individual.