Beneficiary Designations

Beneficiary Designations Remarkable Transactions. Remarkable Partner. The information contained herein is for general informational purposes only. CSi is not a licensed provider of legal services and nothing contained, expressed or implied in this document is intended as, nor shall be construed or understood as, legal advice. No attorney-client relationship is established between you and CSi through this document or under any circumstances whatsoever. If you have questions about any subject matter expressly or implicitly referenced in this email, CSi recommends that you seek compliance, legal or tax counsel regarding any questions or concerns related to your specific circumstances or practices. 2012 Compliance Systems Inc

Beneficiary Designation When an IRA owner dies, any IRA assets that remain in the IRA must be transferred to the beneficiary of the IRA. If the IRA owner has not executed a beneficiary designation, the assets must pass in accordance with applicable state inheritance laws. Although inheritance laws can vary substantially from state to state, in most states, when no beneficiaries are named through a beneficiary designation, it means the IRA assets will become part of the IRA owner s estate upon death, and this generally means probate court. Not only does this method of transfer increase the potential for disputes over ownership of the IRA assets, it can negatively affect the distribution options available to the beneficiary with significant income tax consequences, so while it is not required, it is highly recommended that IRA owner s use a beneficiary designation form to name beneficiaries. Types of Beneficiary Designations IRA owners have the right to designate any person(s) or entity(ies) as a beneficiary. However, it is up to each financial institution to determine what types of beneficiary designations will be accepted. Some financial institutions accept only the financial institution s standard beneficiary designation form, while other financial institutions may accept certain beneficiary designations drafted by an IRA owner s attorney in addition to the standard version that the financial institution makes available. When financial institutions accept beneficiary designations other than the standard version, it is recommended that the financial institution s attorney review the beneficiary designation for validity, or alternatively the financial institution s attorney might draft a set of guidelines to be followed when dealing with beneficiary designations other than the financial institution s own standard version. Primary versus Contingent (or Secondary) Beneficiary Most beneficiary designations will allow the IRA owner to name primary and contingent beneficiaries. A primary beneficiary is a person (or entity) designated by the IRA owner to receive his or her IRA assets when he or she dies. Although the term may sound exclusive, an IRA owner may name as many primary beneficiaries as he or she likes. A contingent beneficiary is an individual (or entity) intended to replace the primary beneficiary(ies) only if the primary beneficiary(ies) dies before the IRA owner. As long as one primary beneficiary survives the IRA owner (or does not execute a qualified disclaimer), contingent beneficiaries (also commonly referred to as secondary beneficiaries) are not considered for inheritance purposes. Pro rata Versus Specified Percentages When there are multiple beneficiaries named, most beneficiary designation forms are designed to allow the IRA owner to specify percentages of the IRA to be inherited by each beneficiary, and when no percentages are designated, the form s default is that the assets are inherited pro rata. This is the default provision used with CSi www.compliancesystems.com TEL 800.968.8522 Page 2 of 6

documents. When IRA assets are inherited pro rata, it means they are inherited proportionally, that is, they are distributed in equal percentages among all the members of the same class (for example among primary beneficiaries, or, in the event that all the primary beneficiaries are deceased at the time of the IRA owner s death, among the surviving contingent beneficiaries). Note: Many people confuse the term pro rata with per capita. The term pro rata describes a way of allocating inheritance percentages, while the term per capita describes one of two ways a designated beneficiary s share will pass to other beneficiaries in the event that he or she predeceases the IRA owner (the other way is per stirpes, and both per capita and per stirpes designations will be discussed later in this section). Example: Macon Monet establishes an IRA and names his four children, Levin, Lotta, Lucien, and Ernie, as primary beneficiaries, but he does not specify what percentage of the IRA each child should receive. According to the default language on the beneficiary designation form, if no percentages are specified, each named beneficiary will receive a pro rata portion (i.e., equal portions) of the IRA upon Mr. Monet s death. Assuming that all Mr. Monet s children survive him, when he dies, his IRA will be split into four separate sub-accounts for each child, each representing 25% of the value of the IRA as of the date of Mr. Macon s death. If, instead, Mr. Monet had named specific percentages for each beneficiary, each beneficiary would have received the percentage of the IRA he had specified on the beneficiary designation form (providing all percentages added up to 100%). Per Capita versus Per Stirpes Two of the most common methods used to determine which beneficiaries are to receive IRA assets upon the death of an IRA owner are per capita and per stirpes. If all the beneficiaries initially named on a beneficiary designation survive the IRA owner, there is very little difference in the way these two methods work. However, if a named beneficiary dies before the IRA owner, whether a beneficiary is named as a per capita or a per stirpes beneficiary has a significant impact on what happens to his or her share of the IRA upon the death of the IRA owner. The term per capita literally means by heads. When a primary beneficiary predeceases an IRA owner under a per capita designation, his or her share is reallocated, pro rata, among the remaining surviving primary beneficiaries. If there are no other surviving primary beneficiaries, the deceased beneficiaries share would be distributed among the named secondary beneficiaries according to the directions of the beneficiary designation. This is the default provision used with CSi IRA documents. Example: Macon Monet establishes an IRA and names his four children, Levin, Lotta, Lucien, and Ernie, as primary beneficiaries using a per capita, pro rata allocation method. Assuming that all Mr. Monet s children survive him, when he dies, his IRA will be split into four separate sub-accounts for each child, each representing 25% of the value of the IRA as of the day of Mr. Macon s death. If, however, two of Mr. Monet s children died before him, the IRA assets would be divided pro rata (evenly) between the two surviving primary beneficiaries. The term, per stirpes, literally means per branch. With this allocation method, the IRA owner specifies which members of his or her family are to receive a share of the IRA, and each beneficiary s branch, or heirs, is guaranteed the specified share of the IRA, even if the initial beneficiary dies before the IRA owner. The IRA www.compliancesystems.com TEL 800.968.8522 Page 3 of 6

assets of the deceased primary beneficiary would not be allocated to the surviving primary beneficiaries, as it would be with the per capita method, but rather to the deceased beneficiary s heirs. Although per stirpes is not the standard allocation method used with CSi documents, if the financial institution allows, a custom beneficiary designation may be drafted to accommodate this. This is typically done by the IRA owner s attorney and approved by the financial institution or drafted by the financial institution s legal staff and used as per their own policy. Note: Since a person s legal heirs are determined by state laws, a per stirpes designation may have different impacts depending on which state s inheritance laws apply. Example: Assume that Mr. Monet s son, Lucien, who was to receive 25% of Mr. Monet s IRA upon Mr. Monet s death, dies before Mr. Monet. When Mr. Monet dies, under applicable state law, Lucien has five legal heirs, and each is to receive an equal portion of Lucien s portion of Mr. Monet s IRA. Therefore, each of Lucien s five heirs will receive equal portions of what Lucien would have received as beneficiary of his father s IRA, or 5% each. The inherited shares of the primary beneficiaries who survived the IRA owner are unchanged. Beneficiary Designations in Community Property States (Spousal Consent) While there are no universal spousal consent requirements for IRAs, states that have laws governing the property rights of spouses known as community property or marital property laws are applicable. If a person, or a person s IRA, is under the jurisdiction of a community or marital property state, his or her spouse must consent if someone else is named as the primary beneficiary of the IRA. If a spouse does not consent to an IRA owner naming someone other than him or herself, and the laws of one of the community or marital property states apply, the assets may not be received at all, or in part, by the nonspouse beneficiary(ies) named by the IRA owner on the beneficiary designation. There are currently nine community property states (Alaska (if a married couple opts in ), Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, and Washington). Wisconsin is the only marital property state. Governing Documents When establishing an IRA, the IRA owner will typically designate the primary (and possibly contingent) beneficiaries for the plan. In many cases, this designation is part of the plan establishment process and the document to capture the beneficiaries may be included in the initial document set. When using the CSi standard IRA document set, the provision associated with the naming of beneficiaries can be found in the IRA Plan Agreement. According to the Plan Agreement, upon the IRA owner s death, the IRA assets will be paid to the primary beneficiaries in equal shares, unless indicated otherwise (for example, a separate document that was drafted by either the financial institution or the IRA Owner or their attorney and accepted by all parties). If no primary beneficiaries survive the IRA owner, then the IRA assets will be paid to the surviving contingent beneficiaries, in equal shares, unless indicated otherwise. If no primary or contingent beneficiaries survive the IRA Owner or if the IRA owner failed to designate beneficiaries during his or her lifetime, the IRA assets will be paid to the estate following the IRA owner s death. www.compliancesystems.com TEL 800.968.8522 Page 4 of 6

It is important to note here that all references to the beneficiaries of the IRA are named at the plan level and not at the individual deposit investment vehicle that may exist within an IRA. For example, an IRA owner may have a single Traditional IRA that includes multiple Certificate of Deposit investments. Best Practices Based on references in the IRA governing documents that refer to beneficiary designations at the plan level, care should be taken to ensure that beneficiary designations are not allowed on the individual deposit investments within an IRA Plan. By restricting beneficiary designations to the plan level, the following can be avoided. 1. Inconsistent beneficiary processes When beneficiaries are named only at the plan level, the financial institution can be assured that per their policy, they have a single place to go for inquiries about or changes to the IRA owner s beneficiary designations. This eliminates the need to verify who was named specific deposit vehicles used within a single IRA plan. 2. Discrepancies between IRA beneficiary share of IRA assets at the plan level versus the individual deposit level When an IRA Owner names beneficiaries at the plan level and is also allowed to name beneficiaries at the deposit investment level, the beneficiary shares can quickly get out of line with the original plan level designation. Example: Macon Monet establishes an IRA and names his four children, Levin, Lotta, Lucien, and Ernie, as primary beneficiaries, each with equal shares in the IRA of which there is $100,000. Mr. Monet then opens four IRA CDs, each with $25,000 and he names each child as beneficiary of one of the CDs. If the CDs are not exactly the same, with the same terms, compounding, fees, penalties, one CD could grow faster than the others, thus making the overall share percentages out of alignment with the original designation at the plan level. At the time of Mr. Monet s death, there is a discrepancy in the original intent of the plan establishment declarations with the share of total IRA assets to the actual assets, as separated by individual CDs, thus opening up the financial institution to possible litigation when paying out to beneficiaries. 3. Discrepancies between named beneficiaries at the plan level versus the deposit investment level When an IRA Owner names beneficiaries at the plan level and is also allowed to name beneficiaries at the deposit investment level, there is an opportunity for inadvertently making changes to the deposit level beneficiary without aligning that change with that originally declared in the plan establishment, thus causing a discrepancy of which beneficiaries are entitled to the IRA assets at the time of the IRA owner s death. Example: As in the previous example, Mr. Monet establishes an IRA and names his four children, Levin, Lotta, Lucien, and Ernie, as primary beneficiaries, each with equal shares in the IRA. Mr. Monet then opens four IRA CDs, and he names each child as beneficiary of one of the CDs. A few years later, Mr. Monet changes the beneficiary of one of the CDs without realizing the impact on the plan (for example, from Ernie, to Ernie s son, Bert) and now the plan level designations would be out of alignment with those named at the plan level. At the time of Mr. Monet s death, there is a discrepancy in the original intent of the plan establishment declarations with the now named beneficiaries at the deposit level, thus opening up the financial institution for possible litigation when paying out to beneficiaries. 4. Handling Required Minimum Distributions (RMDs) without impacting beneficiary shares of the total IRA assets. www.compliancesystems.com TEL 800.968.8522 Page 5 of 6

Beginning in the year in which the IRA owner attains age 70 ½, they must begin taking RMDs. Generally, this RMD amount is determined using the IRA balance or fair market value in the IRA plan on December 31 of the year preceding the year for which the RMD is being figured. Once the amount of the RMD is calculated, the IRA owner may direct their preference of deposit investment from which the distribution is to be taken. They may elect to take the RMD, for example, from the CD that has the lowest interest rate, or is nearing renewal. If the IRA owner had named beneficiaries at the deposit level, he may inadvertently impact one beneficiary's share of the total IRA assets over that of another beneficiary. Upon the death of the IRA owner, it will be too late to clarify his or her intentions for the distribution of the IRA plan to named beneficiaries. It is important to complete a beneficiary designation form, whether standard or drafted by an attorney, that details the wishes of the IRA owner regarding the distribution of assets upon the IRA owner s death. By maintaining the designations at a plan level rather than the deposit level, the financial institution will be in a better position to monitor updates that may occur in the designations during the life cycle of the IRA and assure a trouble-free distribution of plan funds to the intended beneficiaries upon the death of the IRA owner, avoiding the need for probate or the exposure of the financial institution to the risk of litigation. www.compliancesystems.com TEL 800.968.8522 Page 6 of 6