IRA beneficiary designation

IRA Beneficiary Designation Controls Distribution at Death

We’ve written about this issue before. Generally, your IRA beneficiary designation will control who receives your account. Your will (or trust) provisions will not override the beneficiary designation. Arizona’s community property rules won’t have much effect — in fact, they will normally have no effect. It’s all about your IRA beneficiary designation.

Of course, people often fail to lead their lives according to tidy legal rules. Lawyers are often quick to insist that they have a new take on long-established principles. Sometimes the law moves — but usually very slowly. For the time being, here’s the most important thing about your retirement savings: the IRA beneficiary designation will decide who receives your account.

John Fairbanks and his IRA

In 2001, John Fairbanks married Eva. He was about to receive a distribution from his employer-sponsored retirement account. He had two sons from earlier marriages.

A year later, John took his retirement distribution and rolled it over into a new IRA account. He designated his wife Eva as the primary beneficiary.

By late 2012, John and Eva’s marriage was in some trouble. John contacted the financial institution and asked to change his IRA beneficiary designation. He wanted to name a trust he had established to receive the IRA proceeds on his death. The financial institution told him that they would not make any changes without his wife’s consent. He apparently never followed up.

Shortly after that contact, Eva filed for divorce. Neither John nor Eva did anything after that to get the divorce finalized. When John died two years later, they were still married — and Eva was still named on John’s IRA beneficiary designation form.

The probate proceeding

Eva filed a petition with the Arizona probate court, asking to be appointed as personal representative. John’s two sons objected; they filed his last will and his trust, which made clear that they were to be beneficiaries of John’s estate. The real dispute, though, was over the IRA beneficiary designation.

John’s sons insisted that he had tried to change the beneficiary on his IRA to name his trust, and that his estate planning documents confirmed that intention. The probate court ruled that it did not matter; when John died, his named beneficiary would receive the entire IRA account.

Wait a minute, argued the sons. Because Arizona is a community property state, shouldn’t John have had a community property interest in his own IRA? Shouldn’t at least half of it be subject to his estate planning documents?

No, ruled the probate court. The IRA beneficiary designation was a non-testamentary transfer, and John’s will and trust were irrelevant. An earlier Arizona case talking about the surviving spouse’s community property interest in an IRA account was unhelpful for John’s sons’ argument.

The Court of Appeals agrees

John’s sons appealed the probate court ruling. Last month, in an unpublished decision, the Arizona Court of Appeals agreed with the probate judge.

IRA beneficiary designations generally control distribution of an IRA, said the appellate court. There are some limited exceptions (like a completed divorce), and the surviving spouse might have a community property interest in the IRA. But that doesn’t mean that the beneficiary designation can be overruled. After his death, John did not retain a community property interest in his own IRA. The IRA beneficiary designation, once again, rules. Matter of Estate of Fairbanks, February 19, 2019.

What could John have done differently?

Let’s imagine that someone in John’s position really, really wants to change the beneficiary from his spouse to his trust (or his children, or anyone else). Could he have accomplished that goal?

We might start with the IRA custodian. Why did they refuse to change the beneficiary designation unless John’s wife consented?

Because they worried that she might have a community property interest in the account. If they allowed John to make the change, they might be setting themselves up for a legal fight later, when she claimed that the account should have gone to her. That earlier Arizona case might have protected the custodian, but they are more interested in avoiding litigation than in winning it.

Could John have moved his IRA to another custodian who would let him make the change? Perhaps. But he apparently just let the matter drop. If changing the IRA beneficiary designation was important to him, he should have consulted a lawyer familiar with divorce proceedings and worked through his options.

Another choice would have been to get an agreement from Eva, his wife. Might she have agreed to a beneficiary change? Perhaps — especially if was something else equally important to her.

Finally, John might have completed the divorce itself. The divorce decree should resolve ownership of the IRA — and the beneficiary designation.

But wouldn’t Eva have been entitled to half of John’s IRA? Not necessarily. Just because Arizona is a community property state, it does not follow that all assets are jointly owned. From the Court of Appeals’ recitation of facts, it sounds like John’s IRA was probably his separate property, earned before the marriage.

The moral, as we’ve said before: beneficiary designations rule. Except, of course, when they don’t.

 

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