Beneficiary Mistakes — Self-Directed 401(k) or IRA

Designating a proper beneficiary is essential for retirement account holders to guarantee their interests will be served. Whether you're using a Self-Directed IRA or 401(k), you want to ensure that you are doing the most you can for the appropriate beneficiary. Other investors have made critical errors in judgment on this subject, but you can fortunately learn from their mistakes. Today, we are going to talk about major mistakes investors make regarding their Self-Directed 401(k) or IRA's beneficiary, and how to avoid making them yourself.

Mistake #1: Naming Your Child as Your Beneficiary

Most people immediately want to name their child as a beneficiary. This is only natural, but if your child happens to be a minor, things can get extremely complicated. Run this scenario through your head: if you're hit by a bus tomorrow, will your 8-year-old know what to do regarding your retirement account? Do most 8-year-olds even know what an IRA or 401(k) is, let alone how to responsibly direct one?
Even if your little angel is a MENSA-qualified financial prodigy, it is nearly impossible that a court would allow your tiny genius to directly receive your plan's benefits.
Some investors believe they can avoid this issue by simply designating their child as a secondary beneficiary, with their spouse as the primary. But if something should happen to both you and your spouse, you're still going to run into the problems above. Fortunately, there is a simple solution for these situations: appoint a guardian to represent your minor child's interests in your plan. Note that you'll want to do this yourself. If you don't, the judgment call will be up to the court. Make the choice while you can so you know your child will be protected by a person you trust.

Mistake #2: Bungling The Beneficiary Form

There are several ways your beneficiary designation form can actually sabotage the person it is intended to help. The most obvious of these is lacking one altogether. But let's assume you did everything correctly when filling out and filing the form. Don't skip this next critical step: let your beneficiary (and ideally your attorney) know where it is.

If you don't, you're adding even more troubles to your already grieving loved ones. We recommend that you not only provide copies of your form to all interested parties, but that you also keep an additional copy in a home safe or safety deposit box. Anyone who needs the form, from your professionals to your heirs, should be notified ahead of time of the copy's secure location.

Solution: Help Your Beneficiary Efficiently in Other Ways

Of course, when you name a beneficiary, you are hoping that he or she will actually benefit from your account and its investments. While they likely will, we have found that there are limits on how much a Self-Directed IRA or 401(k) can actually do for your chosen party. To be precise, there's one big limit: Uncle Sam.
Uncle Sam likes his money. He will always get it. And getting it from your retirement account upon your passing is child's play for Uncle Sam. Every dime that goes to him is essentially coming out of your beneficiary's pocket. That brings us to one of the most common-sense ways to look after your loved ones: life insurance.
Life insurance is an incredibly valuable tool, particularly if you have children. Yes, you will pay premiums for the policy, and they may be expensive. But in the event of your death, the benefits will pass directly to your heirs without the Taxman getting in the way.

Last Updated: 
July 25, 2018

Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.

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