Retirement Accounts – Some of the Hidden Dangers and Pitfalls to Avoid

In this episode, John Ross and Lisa Shoalmire discuss the hidden dangers of retirement accounts.

Episode Transcript
John
Welcome to another edition of Aging Insight. I'm your host, John Ross, here with my partner and co-host, Lisa Shoalmire, and we are elder law attorneys right here in your neighborhood. And we come on this show to address the kind of issues that people have as they get older, the kind of things that they're concerned about, maybe answer some of those questions that you've had lingering out there, or maybe even identify some issues that you didn't even know existed. But what we do know is that people have concerns; They don't wanna go to nursing homes, they don't wanna become a burden on their friends and family and they don't wanna go broke trying to pay for their care.
John
They want this to be a smooth transition. They call these the golden years, and if it's the golden years, then it should be fun and easy and nice. And we know that that is actually possible, your golden years can be golden. But there's a lot of ways it can go wrong, and if you arm yourself with the kind of knowledge that we provide right here, you can make it on your own terms the way you want. Now, our topic for today is retirement accounts. In fact, our topic today is the hidden dangers of retirement accounts. Most people, when they think about retirement accounts, they think about "these things are great."
Lisa
Well, usually, they think, "I don't have enough in there." [chuckle]
John
Yeah, yeah, that's right.
Lisa
That's the first thing they think. But, John, we're fortunate that in our community... We live in a community that has a number of employers such as... That are in manufacturing or healthcare that offer their employees 401 [k] retirement plans, or guidance and contributions to employees and their IRAs or Individual Retirement Accounts. And these type of retirement plans are just critical to our community members as they get into retirement and think about retiring someday. So our topic today really might concern some of our younger viewing audience as they look a little closer at these retirement accounts and avoiding these dangers. But, John, when you go to work for an employer that has a retirement plan, usually the paperwork involved with signing up for that retirement plan, it's offered to you when you're doing all of your employment paperwork.
Lisa
And a lot of times, retiring is not the first thing on your mind. You're starting this new job, you're getting the paperwork done, you're going trough your orientation. A lot of times, that HR person is putting scores of papers in front of you. "Sign here, check here, you'll need to designate a beneficiary here. We're gonna issue you safety equipment, sign here that you're gonna be responsible... " There's a lot going on. Oftentimes, that retirement agreement document, there's just not a lot of thought given to it on that front end when that employment is accepted.
John
Right, there's not a lot of attention paid to the details. The big picture, people get. I'm gonna take some of my income and I'm gonna contribute it to my retirement account. They're gonna take the money directly before it ever get's paid to me and it's going to go into my retirement account, where it grows tax-free. And maybe my employer even takes some of their money and matches what I contribute, and over time, it's gonna grow and it's gonna get bigger, and when I eventually retire, I'm gonna be able to get this money out. That's the big picture. But as we say on here so often, details are important. Because what happens while you're alive with this account, what happens when you die with this account, those can be some big issues. The first thing is like you were taking about, Lisa, they're sticking these papers in front of you, and when you sign up for this account, one of the first things they're gonna ask you is, "Who gets it when you die?"
Lisa
These are personal decisions that really aren't limited by the space on the beneficiary designation form.
John
Yeah. That's absolutely right. It's not uncommon in our practice where we're trying to match up those beneficiary forms with the other planning that we have done, and oftentimes, we will prepare statements. I've had them be several pages long that become the new beneficiary designation as an attachment to that forms. So, yeah, you're not limited by the form, however, sometimes you can be limited by the law.
Lisa
Well, that is true enough. For instance, with 401 [k] accounts, these are very common retirement accounts offered by employers. And the law is going to dictate a lot of what your beneficiary designations can be. I think we'll take a break and we'll talk about the pitfalls of the conflict between the law and a beneficiary designation. So stick with us, we'll be right back.
Lisa
Welcome back to Aging Insight. I'm Lisa Shoalmire and I'm here with John Ross. And today, we're talking about some of the hidden dangers, or pitfalls in retirement accounts. Specifically, I wanted to bring up that there is a conflict between what the law says you can do and what you can actually write on a beneficiary designation form when it comes to a 401 [k] account. Let's imagine that you are a single man and you go to work for an employer and you list your three children as beneficiaries on your 401 [k]. These kids could be minors, they might be grown, but regardless, the employee himself is single for some reason. Well, let's say that employee gets married. Now, the employee may have consciously thought, "Hey, I'm not gonna change anything about my 401 [k] because I want my kids to get it if something happens to me anyway." Maybe they even consciously decide that's the beneficiary designation works and they don't need to change it. But if that employee, after they marry, if they die, the new spouse, under the federal law that governs retirement plans, the new spouse will receive 100% of that 401 [k] plan balance.
John
Yeah. Which is certainly not what the guy intended.
Lisa
Right. And this exact situation happened to a gentleman down in Baton Rouge, Louisiana, and his new spouse of just six weeks got the entire balance of his 401 [k] because there was a conflict. What the law says, a 401 [k] must be paid to the spouse unless... And here's the trick and the pitfall I want you to watch out for, if you want that 401 [k] to go to someone besides your spouse, your spouse must sign a notarized and acknowledged waiver of their rights in that 401 [k] account.
John
Right. And this can be a tricky thing to do. And it's one of those things where those beneficiary designations can jump because the beauty of life is that it changes, and you might not be married to the person who you had named on that form. In fact, there was recently a big Supreme Court case, where somebody had named a spouse as a beneficiary, divorced that spouse, remarried, and then did not change the beneficiary designation from the first spouse to the second, died and the benefits were actually paid to the first spouse 'cause they were still the named beneficiary. There can be lots of different things. It depends on the type of account whether it's a traditional IRA, a 401 [k], a SMP, a SIMPLE or any of these other thousands of different types of accounts, they all have their own rules, and it can be pretty confusing out here. And there's always the possibility of unintended consequences.
John
You might be sitting there, thinking, "Well, John, Lisa, I get all of that but I've already got everything payable to my spouse. It's all fine and dandy. Why would I ever wanna change that if my spouse is alive? When I die, I want everything to go to her, right?" That makes perfect sense. Except that, think about what happens when the two of y'all are both 85 years old and that spouse has Alzheimer's and cannot care for themselves and you're the caregiver, and then you die. And now, you've got those assets paid to a spouse who cannot manage her own affairs or his own affairs, might need some sort of government assistance to help pay for nursing home care or in-home care, and by naming that spouse as the beneficiary, you've just disqualified them from all kinds of things. You might have even created other heartaches like somebody having to get a guardianship in order to deal with those funds.
Lisa
In this situation, the bottomline is because life changes all the time, the designations that you make for your retirement should also change over time. If you're a younger person with a spouse, if there's a change in your marital circumstances, you need to call your HR department and get that beneficiary designation form for your retirement plan and take a look at it and make sure that it's what you want. Also, if you're a younger employee with a retirement account, you wanna make sure and adjust that account anytime you add to your family. I've seen situations where a younger employee has left the retirement account to the spouse, and then that contingent beneficiary was that son that was born to them. Well, later on, they may have a daughter, but the employee never goes back and adds the daughter as a contingent beneficiary on that account. If the parents are in a common accident and they perish, well, now the entire account is only gonna go to that son, and the daughter is left completely out in the cold and no assets. And obviously, that is not what the employee intended, but because they didn't keep up with the changes with their family circumstances and make those changes on their retirement account designations, they have an unintended consequence, a definite pitfall.
John
Right. And maybe you're the parent of this young employee. Maybe it's your son or daughter who's just gotten this great job and they're not married, they don't have any kids. They're just out of college and they've started this new job but they do have this retirement account. And, oftentimes, I have seen where those young folks, not knowing who to name, they just didn't name anybody. And then, unfortunately, bad stuff can happen, and we have seen situations where that young worker dies in a car wreck or something like that and the family has to jump through a tremendous amount of hoops in order to get access to those funds and figure out, do they go to the parents? Do they go to the brothers and sisters? And they typically have to go through the court system which can be quite expensive in many cases. If you're that older, wiser generation out there, pass this same information on to that younger worker and tell them, "Hey, look, even if you don't have any kids or a spouse, you do have this asset and you need to figure out who it's gonna go to because it'll save everybody a lot of time and effort."
Lisa
Well, John, and something else I've heard from a client sitting in my office is, when I've asked them about what the status is of their retirement accounts and the designations that they've made, they may tell me something that an ex-spouse or someone is listed but yet they're not worried about it because, number one, a friend told them that an ex cannot inherit any property. And number two, they'll say, "Well, in my divorce decree, it says that my retirement is all mine." And these are two points of state law that are... There's a shade of truth in them, certainly, for many other assets except for retirement accounts.
John
Right, because most of those retirement accounts are gonna be governed by federal law and the way our legal system works is if there is a conflict between what the state law says and what the federal law says, the federal law wins every single time. And so, yeah, lots of people have heard something about that state law, but not realizing how some other law out there steps in and trumps it. As you can see, there's lots of little issues with all of this and of course, all of this is just related to those naming of beneficiaries when you die. Those same accounts can cause problems while you're still alive. We're gonna talk about that when we come back from our next break. So stick around, and we'll keep talking about the pitfalls of IRAs and retirement accounts. We'll be right back.
Lisa
Welcome back to Aging Insight. I'm Lisa Shoalmire, here with John Ross. And today, we're talking about the pitfalls and dangers of dealing with retirement accounts. Our previous two segments of the show today have really been about beneficiary designations and making sure you account for changes in your family circumstances. And you make sure that your beneficiary designations are the way that you want them and that you understand how the law applies to those designations. But like John said before the break, all that has to do with who gets your accounts at the time of your death. But you know what? These accounts are something that are accumulated during your lifetime, and so, while you're living, these are assets that you may have to deal with, and you need to be careful, because there can be some pitfalls even while you're living. Now, John, most of these accounts are a way to sock away some money and have that money grow in a tax-free environment. If that money is earning interest and dividends, you're not paying taxes on it as you go.
John
No, right. You either got a tax deduction when you put it in or you never pay tax dollars on the money because it came straight from your employer. And it has since gotten bigger and bigger and bigger, all without any tax consequences, because when you start drawing it out at some point in time, that's when you're gonna pay tax on it.
Lisa
And of course, the idea here is while you're an active worker, that you're in a larger tax bracket and it's good to have these tax-free growth or the tax deductions for making those contributions. And most of us, our income typically goes down a bit in retirement. And so, when we start accessing these accounts in our retirement years, the hope, frankly, is that the tax rates are a bit lower on us individually.
John
That's right. And of course, any time before age 59 and a half, if you touch any of the dollars in that 401 [k] or IRA, you're gonna pay a penalty. After age 59 and a half, you can start withdrawing that money without a penalty but you still have to pay taxes on it. And of course, when you reach age 70 and a half, you have to start drawing money out of it. What's called a required minimum distribution, which is an amount you have to take out of that IRA so that it starts becoming taxable. Well, that's all fine and dandy, but what if you need to get a lot of that money out for some particular reason? That could create a gigantic tax bill at some point. And a lot of times, people don't think about the fact that these things are very inflexible when it comes to how they interact with the rest of your estate planning.
John
For example, what if I told you that I could create a trust that you're still in control of your own assets, you can still benefit from those assets, but if at some point in time in the future, you needed to go to the nursing home, the value of those assets would not count towards your eligibility for something like Medicaid to pay for that nursing home. In other words, you could have your assets, be in control of your assets and not have to worry about losing them if you go to a nursing home. You might say, "Well, John, that sounds like a terrific idea." And for many people, that type of vehicle is a great tool. But, so many times I've talked to folks and I've said, "You know what, this is a great tool. And we could use it to protect your house and your land and your CDs at the bank, and we could protect anything with this type of trust, but you can't transfer an IRA into it or a 401 [k] into it, not without creating a tax problem, because those accounts have to be owned by that person in that person's name."
John
That's right. A lot of times, these accounts, that's where a lot of folks' wealth is located as they come into their retirement years is they've, hopefully, maybe they've been real conscientious savers into those retirement accounts, and so now, they have a home, they have some free cash in CDs, but the bulk of their estate is located in an IRA. We cannot make trust beneficiaries of that IRA. We cannot make distributions out of that IRA as gifts to our children or grandchildren without taking the money out of the IRA, paying the taxes connected with those funds, and then doing something with the funds.
John
That's right. A lot of times, if you have those kind of accounts, again, if you're looking forward down the road, depending on what other assets and stuff you have, it may actually be more beneficial to start taking money out of that IRA type account, paying a little bit of tax on it but getting it into a what's called a non-qualified investment. In other words, one's that's not governed under all of these restrictive IRS rules, so that either now or at some point in time in the future, you'll have more flexibility to be able to protect those assets, because in many cases, it might be better to pay a little tax now than have to spend every penny of it later.
Lisa
Well, and John, that's hard for a lot of folks because they're so conditioned not to touch the IRA, and that their CPAs are conditioned to tell them not to touch the IRA. But as you get into retirement, it's appropriate to really have a check up and check in and get some good advice about some planning options that you might have.
John
That's right. And of course, where do you get good advice? Well, lots of different places but one of them, right here on Aging Insight. And if we haven't answered your question, you still have questions out there, one of the things you can always do is call in to our live radio talk show, Aging Insight. It's on 107.1 every Saturday at noon and you can call in, ask your question and get an answer right that very second.
Lisa
We've enjoyed having you with us today and we would encourage you to check those beneficiary designations on your retirement accounts and give some thought to creating some additional flexibility in your estate plan in the future. Stick with us and be back here next week for another edition of Aging Insight.
John
Bye-bye.

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