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Gimme Shelter
By Karen Hube, January & February 2005
Oops! He left some life insurance to his ex-wife. Is his widow going to get soaked?
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Shortly after her husband died last fall, Jane Raines, 62, made a
surprising—and alarming—discovery. While she and her husband,
Andrew, 68, had planned for their future financial security, they had forgotten
one crucial "to do." They had never reviewed the beneficiary
designations on Andrew's retirement accounts and life insurance policies.
Unfortunately, the beneficiary on the $52,000 life insurance policy with his
employer was still his ex-wife, from whom he had been divorced for a decade.
While Andrew had a $60,000 supplemental life insurance policy naming Jane as
beneficiary, she could surely use the other $52,000—and she's sure
Andrew would have wanted her to have it. Andrew also failed to name a
beneficiary to his $80,000 IRA. Jane worries she'll never see any of the
cash.
The Problem
Like many people, Andrew didn't take the beneficiary designations on his
accounts too seriously. After all, he had a will in which he left everything to
Jane. And "everything" means everything, right? Well, not exactly.
"Proceeds of life insurance policies are generally paid according to the
beneficiary designated," says Michael Bartholomew, senior counsel at the
American Council of Life Insurers. That's why it's critical to review
your beneficiary designations every few years or so, he says, especially after
a divorce or remarriage.
The Plan
Jane's first step is probably the hardest: she should kiss away that
$52,000. Unless Andrew's ex-wife hands it over (dream on), it's
hers.
IRA beneficiaries also override the will. When no beneficiary is named, the
assets generally go to the estate, and the estate is paid out according to the
will (meaning, in this case, they go to Jane). But one catch when an IRA goes
to an estate rather than a person is that by law, the assets have to be cashed
out of the IRA by the end of the fifth year following the year of death. That
means Jane would have to cash out Andrew's IRA by year-end 2009,
potentially losing years of tax-deferred growth.
Fortunately for Jane, so many people have mistakenly not named an IRA
beneficiary that the IRS has recently issued rulings saying that a spouse who
inherits the majority of the rest of the estate (as Jane did) doesn't have
to cash out of the IRA in five years, says Ed Slott, C.P.A., an IRA expert in
Rockville Centre, New York. The difference is huge: by keeping the IRA intact,
Jane will have at least eight years of growth on the $80,000. At 70½,
she'll have to take minimum distributions, but she can keep the bulk of the
money in the IRA, where it will grow tax-deferred.
But don't assume now that you can leave the IRA beneficiary line blank
and it will go right to your spouse. "If you have part of your estate left
to other people besides your spouse—say 25 percent each to two kids from
a previous marriage—then they can contest the IRA," says Donald
McCoy, a financial planner in Minneapolis.
The moral? "In most cases, it's best to name a human being as your
IRA beneficiary," says Slott. "It can mean thousands of dollars over
a generation."
Karen Hube has written for Money magazine and The Wall Street
Journal.
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