Reading the fine print of a custodial agreement for anindividual retirement account is about as exciting as the idea ofhaving blood drawn. You're probably more focused on the IRA'sinvestment options or rolling your 401(k) plan account into the IRAwithout running afoul of tax rules. Those are worthy issues, to besure, but don't ignore that custodial agreement.
One reason to thoroughly read your custodial agreement -- orhave your financial planner read it and explain it to you -- is thatcustodial agreements don't necessarily have to match the InternalRevenue Service rules and regulations. Custodial agreements can be morerestrictive.
For example, IRS rules allow the beneficiary or beneficiarieswho inherit an IRA to name their own beneficiaries. Commonly a parentwill name a child the beneficiary on an IRA inherited from the parent'sparent. If Joe inherits his dad's IRA, he can stretch out the taxdeferral by making minimum distributions over his life. By naming hisdaughter Sally as his beneficiary, she can do the same thing after Joedies, thus continuing tax deferral.
But the custodian of the IRA, such as a bank, brokerage firmor mutual fund, doesn't have to permit the beneficiary to name asuccessor beneficiary. When the owner dies, some custodians require theIRA assets to be paid out to the owner's estate in a lump sum, causingthe loss of deferral and an immediate, and potentially large, tax bill.Fortunately, most custodians allow such stretch IRAs, but not all do,so read the agreement carefully.
Another provision to check for is what happens if you havemultiple beneficiaries named to an IRA, such as your adult children,and one of them dies before you do. The standard language of custodialagreements call for IRA assets to pass to the remaining beneficiary orbeneficiaries upon the owner's death per capita. That means the assetsare divided only among the surviving beneficiaries.But what if a prematurely deceased beneficiary had children?Under the per capita default, no IRA assets would pass to thosechildren. The assets would pass only to the surviving beneficiaries.Essentially, you disinherited some of your grandchildren.This oversight can be avoided if the language of the agreementsays per stirpes instead of per capita. Per stirpes allows the sharethat would have gone to the deceased beneficiary to be passed to thedeceased's children (or other designated heirs of the deceased).Some custodial agreements that have the per capita provisionas a default allow you to check a box on the agreement form changing itto per stirpes. In other cases, you may have to draft a signed andwitnessed custom addendum instructing the custodian to distribute on aper-stirpes basis. It is a good idea to have the custodian sign theaddendum acknowledging receipt. If the custodian won't acceptaddendums, you may want to consider a different custodian.
Does the custodial agreement allow multiple beneficiaries toyour IRA? The default language of some agreements limits owners to asingle primary beneficiary or is simply silent on the issue.Furthermore, custodial agreements that allow multiple beneficiaries mayprescribe equal distribution of the assets, but you may preferdifferent percentages for different beneficiaries. Again, if allowed bythe custodian, you may need to attach separate language detailingmultiple beneficiaries by name and how you want the assets distributedamong them.What is the agreement's default language regarding a divorceor legal separation in which you forget to remove the name of yourformer spouse as beneficiary? Agreements typically are silent, though afew will automatically revoke the divorced spouse as beneficiary unlessotherwise directed by a divorce decree.Does the agreement allow the custodian to discuss the IRA withthe owner's estate executor or successor trustee who isn't a named IRAbeneficiary? If not, you may have to write that provision into anaddendum.Does the agreement allow the beneficiaries to make atrustee-to-trustee transfer of the IRA assets to another financialinstitution after the owner dies (thus avoiding the payment of incometaxes)? If the custodian does not permit the transfer, beneficiarieseither are stuck with that custodian or would have to cash in the IRAand pay potentially substantial taxes on the lump sum.Gary S. Williams is a senior financial adviser,certified financial planner practitioner and chartered retirementplanning counselor with Williams & Associates.This article originally ran in "The Daily Record,"Baltimore, Md., a Dolan Media publication.Source: St. Charles CountyBusiness Record. Powered by YellowBrix, Inc.
