For many people, IRAs and 401-ks represent their second most valuable asset, after their home. And these assets represent the most frequently litigated issue of estates – because of confusion about how these assets are transferred at the death of the owner.
Most people understand the importance of having a will, but it is important to remember that a will is usually only one component of one’s wealth transfer plan. Cerulli Associates estimates that Americans will engage in a $68 trillion wealth transfer over the next 25 years, with roughly $10 trillion of that transfer occurring through IRAs and 401-k accounts.
It is important to remember that IRAs and 401-ks are transferred at the account owner’s death by beneficiary designation, not by the owner’s will. With longevity increasing, it also increases the unfortunate possibility that the account owner’s offspring may predecease them. What occurs if this happens? That’s where per capita and per stirpes come into play.
Most beneficiary designation forms default to a per capita distribution in the event one of the primary beneficiaries predeceases the account owner (if not specifically noted). Per capita translates into “per head.” Let’s look at what this actually means. Let’s assume Anne (age 92) recently died with a $1 million IRA. Anne’s IRA account was opened 20 years ago and Anne named her 3 children; Bob, Mary and Lee as primary beneficiaries. Unfortunately, Mary died 8 years ago, but she has 2 surviving children (Emily & Mark). Under a per capita distribution, Anne’s IRA would be divided equally between her two surviving children (Bob & Lee). Mary’s children would receive nothing.
However, let’s assume when Anne opened her IRA she elected a per stirpes distribution. In this case, her IRA would be distributed as follows; 1/3 to Bob, 1/3 to Lee, 1/6 to Emily, and 1/6 to Mark.
As you can see, this seemingly insignificant detail can have enormous consequences. It’s important to know that your beneficiary designations align with your wealth transfer intentions, and we recommend regularly reviewing them to assure their continued appropriateness.