Who Will Inherit Your Self-Directed IRA Funds?

Family dynamics can be stressful. Add money to the mix and it gets even crazier. That’s why when the two come together, being proactive is often your best bet. By taking control of the situation from the get-go, you can get ahead of a lot of the family dissent. Your move to clarity will also be doing a big favor for your family by preventing prolonged legal wrangling down the road.

The problem is that sometimes clarifying a matter requires more steps than you might expect. Anytime financial matters and government rules collide, you can expect paperwork to follow. Fortunately, in this instance - choosing beneficiaries for your Self-Directed IRA there isn’t necessarily any additional paperwork. Rather, it’s just a question of filling out the standard forms properly.

Why retirement accounts need special consideration

It’s impossible to predict exactly how long you will live. (If it were possible, life insurance companies would quickly go out of business.) That being the case, it’s very possible that after your passing, there will still be funds in your Self Directed IRA. The question is who gets those funds? You might think that’s not an issue because you’ve already put together a will where everything is spelled out. That was a good move, but the will only works for most of your assets. Retirement plans can play by a different set of rules. The retirement plan itself contains instructions as to who its beneficiaries are, and these designations will usually trump anything that’s written in your will. This one fact has resulted in numerous lawsuits, but almost always the court has upheld the fact that retirement account designations override those of the will.

A Common Scenario

John Smith has a nice family. He has two married children, Jeff and Susan. Jeff has one son and Susan has two daughters. John also has a Self Directed IRA. This retirement account has $400,000 in it. John loves his children and grandchildren and wants upon his passing that they should split his assets equally. What does he have to do to make sure that happens?

Check the Self-Directed IRA Boxes

On the beneficiary form for John’s Self Directed IRA, there are spaces where John can designate who his beneficiaries are. However, even after designating beneficiaries, John has another choice to make. He has to decide if the beneficiary designations are per stirpes or per capita. He could not check the boxes, but then the account will just revert to the custodian’s default setting. That could easily be a situation where John is not happy with the outcome. It’s better that John should know what per stirpes and per capita mean and then choose the one which best reflects his wishes.

Per Stirpes and Per Capita

Ideally when John chooses his beneficiaries, he should be able to anticipate every eventuality and spell out what he wants to happen. However, life can’t always be structured quite so rigidly. Unfortunate events can occur like the death of one his children or grandchildren. In that case, how will the assets of the Self Directed IRA be redivided? That’s where per stirpes and per capita come in.

Per stirpes is a designation which indicates that heirs of a beneficiary should receive that beneficiary’s portion of the assets. In the above example, if John’s daughter Susan passed away before John, then choosing per stirpes would allow Susan’s share to be split amongst her daughters. This is especially important if John only listed his children as beneficiaries. If he doesn’t check per stirpes, then Susan’s death would take her entire family out of the estate and everything would go Jeff, the other child listed.

Per capita is a designation which says that the assets should only be split amongst the designated beneficiaries. If John chooses per capita and designates his children Jeff and Susan as the beneficiaries, then they will split the Self Directed IRA assets evenly. In that case each would receive $200,000. If Jeff predeceases John, then Susan would get the full $400,000. If John expands his beneficiaries to include his grandchildren, then per capita would split the assets evenly amongst the five chosen: Jeff, Susan, and their three children. In that case each would receive $80,000. Then, in that case if Jeff predeceases John, the assets would be redistributed to be split four ways. Susan and the three children would each receive $100,000.

The choice of per stirpes or per capita in a Self Directed IRA very much depends on the family dynamics. Per stirpes allows each “branch” of the family to be taken care of, even in cases of untimely death. However, there are many reasons why a Self Directed IRA account holder may want to shift the asset allocation and choose per capita. It could be one individual in the family needs the funds for a pressing emergency or the converse in that there is a specific reason why they shouldn’t receive any funds.

Updating Your Self Directed IRA

Although it’s not on top of mind for most people, updating your Self Directed IRA’s beneficiaries can save your family a lot of headache later. With any life change like the birth of a child or grandchild, marriage, divorce, or other domestic issues, take a look at your beneficiary designations and see if they still reflect your current situation.

One other important note to keep in mind is the status of a spouse as a beneficiary. For 401(k) plans or for Self-Directed IRA accounts in states that possess Community Property laws, a spouse will be automatically considered the primary beneficiary. It can take a signed waiver to change that fact. Ask your financial advisor about the laws in your state regarding a spouse as a beneficiary and how that will work with your inheritance goals.