Americans have more than $12 trillion stashed away in IRAs, 401(k) plans, and similar retirement accounts. Yet very few people have given careful thought to what will happen to the assets in those accounts if they should pass away unexpectedly. In a surprising number of cases, what would happen is not at all what they would expect – or want.

Over the next decade, as the Baby Boomers continue to age, we will hear many stories of “inheritance disasters” as heirs are surprised by the laws surrounding these accounts. That’s why it’s important to make sure your retirement accounts have been considered as part of a complete estate plan for your family.

Many people assume that if they’ve written a will, then the people they named as heirs in the will are entitled to the assets in their retirement accounts.

Not true! Generally, a will has no effect whatsoever on a retirement account. Who gets the assets in an IRA or 401(k) is determined by a combination of state and federal laws and the “beneficiary designation” form that the owner filled out when the account was first set up, often many years earlier.

The problem with these beneficiary forms is that most people fill them out in a hurry when they’re starting a new job or rolling over an account. They’re not thinking carefully about estate planning considerations at the time.

Once the form is checked off, people tend to forget to update it when they have a change in their life, such as marriage, divorce, the birth of a child, etc. And even if people think to update the form, the plan provider doesn’t always make it easy to do so.

Plus, the forms themselves often make it difficult for people to accomplish what they want. Many 401(k) forms allow only a single primary and contingent beneficiary. What if you want to divide the funds equally among four children?

If a beneficiary form isn’t updated regularly, there are numerous things that can go wrong. For instance:

• A person gets married (or remarried) and doesn’t update the form to include the new spouse. The assets go to someone else.
• A person names their first child as a beneficiary, but doesn’t change the form when a new child is born. All the funds go to the first child and nothing goes to the sibling.
• A person names a minor child as a beneficiary, and since the child can’t inherit the funds directly, the result is a lengthy and expensive court proceeding.
• A person gets divorced, but forgets to change the form, and his or her ex-spouse collects all the assets.
• A grandfather wants the assets to be split evenly between his son and daughter. But the son dies, and the grandfather doesn’t update the form. All the assets go to the daughter, and nothing at all goes to the son’s children.

Many states have laws that say that if a will hasn’t been updated after someone gets married or divorced or has a child, the will can in effect be modified to provide for the changed circumstances. But often, these laws don’t apply to IRAs.

The situation is even worse with 401(k)s, because these are governed by a federal law called ERISA that trumps state laws.

Under ERISA, if a person was married, then in most cases the assets in a 401(k) plan must go to the person’s spouse, regardless of what it says in the beneficiary designation form – unless the spouse signed a notarized waiver. Most people don’t realize this, and very few beneficiary forms spell it out.

This rule tripped up Leonard Kidder, a widower in Baton Rouge who named his three children on a beneficiary form to inherit his 401(k) plan worth $250,000. Leonard remarried at age 66, and six weeks later he died. Thanks to ERISA, his new wife pocketed the entire $250,000 and his children were left with nothing.

ERISA is strict – generally, even if your spouse signs a prenuptial agreement saying that he or she won’t claim your 401(k) funds, that doesn’t matter unless the spouse also signs a notarized waiver after the wedding.

Divorce frequently leads to problems because, in the stress of a separation, people forget to update their forms. In Washington state, a Boeing employee named David Egelhoff died in a car crash two months after divorcing his wife. Since he hadn’t gotten around to removing her as his beneficiary, she collected his company-provided pension plan and life insurance, and nothing at all went to his children by a previous marriage.

What happens if you simply don’t fill out a beneficiary form? Then the assets will go to a “default” beneficiary. Often, the default beneficiary is spelled out in tiny type somewhere in a massive document from the plan provider that nobody ever reads.

Frequently, the default beneficiary is the account owner’s estate. That’s usually a bad idea, because it forces the assets to go through probate. Also, the family may end up forfeiting a lot of tax advantages that could otherwise be available.

Another option is to have the assets go to a trust. This can be a wise idea in certain circumstances – but you have to be very careful, because there are many obscure legal technicalities that must be observed to prevent problems with the IRS.

In general, retirement plan assets will be a ticking time bomb for many families in the coming years. It’s critical to speak to an estate planner to make sure your retirement accounts are integrated with your will and other documents as part of a complete estate plan.