Money & Policy

How Your 401(k) Could Disinherit Your Kids

Even with a will, your retirement account might wind up in the wrong hands

(This article appeared previously on MarketWatch.com.)

If you have a will (and we hope you do), chances are you’ve spent long hours carefully considering exactly how your estate should be distributed among your children or other heirs. But if you have a 401(k) or an IRA, chances are you spent about five seconds deciding who your beneficiary should be. What’s more, you’re likely to have done this 10, 20 or even 30 years ago.

For many families that lose a loved one, this situation spells trouble. If the two documents conflict, it’s the beneficiary designation, not the will, that determines who gets the deceased person’s retirement account assets.

The Out-of-Date Beneficiaries Problem

Conflicts like these have become a thornier issue as more people concentrate more of their wealth in their retirement savings plans, and they’re the subject of a new study by Stewart Sterk and Melanie B. Leslie of the Benjamin N. Cardozo School of Law at Yeshiva University, published in the most recent issue of the New York University Law Review.

(MORE: Americans' Ostrich Approach to Estate Planning)

As you may (or may not) recall from when the last time you opened a new 401(k) or IRA account, savers are almost always required to designate a beneficiary before they start funding the account. These days, it’s typically a formality that people speed through on the web, analogous to the baggage-checking step when you check into a flight online.

And many people tackle this task early in their careers, when spouses and kids have yet to enter the picture; they’ll typically designate their parents, siblings or nieces and nephews as their beneficiaries. (Before I got married, my impressive four-figure IRA was earmarked for my younger brother.)

The Estate Planning Mistake Many People Make
You can imagine what happens next: Time passes; spouses, second spouses and kids enter the picture; and, human nature being what it is, many people forget to update their paperwork. (People who have wills also frequently slip up in this regard, as my colleague Elizabeth O’Brien has noted.)

As people set up their estate plans, many wrongly assume that their wills will determine what happens to their retirement accounts. In fact, the beneficiary designation usually trumps the will, and heirs who try to stake a claim to 401(k) or IRA assets that have been designated to someone else face costly litigation with no certainty of success.

(MORE: The Big Estate Planning Goof You May Be Making)

Flaws in the System
In his most recent “Intelligent Investor” column, The Wall Street Journal’s Jason Zweig describes the plight of several families that have been tripped up by outdated beneficiary paperwork. Citing Sterk and Leslie, Zweig notes that the system would be more consumer-friendly if 401(k) and IRA administrators adopted some assumptions that are common in the law of wills and trusts (for example, that your grandchildren will automatically become your heirs if your children die before you do).

He also notes that many retirement-plan administrators don’t allow account holders to designate more than two beneficiaries — a potentially significant hassle for some larger families.

Clearly, the system leaves a lot of room for improvement; all the more reason to make sure your own accounts are up to date.

Matthew Heimer covers retirement for MarketWatch and edits the Encore blog. Follow him on Twitter @MatthewHeimer.


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