Are My Retirement Accounts Part of My Estate Plan?

Don’t neglect your retirement accounts, when creating or reviewing your estate plan. Knowing who is named as a primary beneficiary and who is a contingency beneficiary of your retirement accounts is important for your wealth distribution plans, in large part because of tax rules governing the distribution of these assets at death, warns Investopedia in its recent article, “Include Your Retirement Accounts in Your Estate.” Always re-examine your beneficiary designations after major life changes like marriage, divorce, or the birth or adoption of a child.

If you don’t designate beneficiaries for your retirement accounts, the designation may default to your estate. That can be one of the worst possible outcomes for your retirement accounts, from a tax and planning standpoint.

If your estate is named as beneficiary, your heirs have to wait until the probate process is complete, before they can access your retirement funds. Be sure to name an individual or a trust as your beneficiary. Each state may have a different requirement concerning who you can name as a beneficiary. For example, the federal ERISA law requires you to name your spouse as the beneficiary of your 401(k) account, unless he gives permission in writing to name another person or charity. Talk to an estate planning attorney in your state.

Another option is to include a trust in your estate planning, instead of distributing retirement funds directly to specific individuals. This gives you more control over the distribution and protects your heirs from additional paperwork and taxes. If you want to leave the assets in your retirement accounts to a relative who you think won’t manage the funds well, you can use a trust to provide regular distributions from those accounts. These regular trust distributions will keep a beneficiary from tapping into their inheritance and spending it all at once.

A trust is also a good choice, if your beneficiaries are minor children who cannot have direct access to the money until they become legal adults. All that noted, however, very careful planning must be done to avoid unintended consequences, when designating a trust as beneficiary of retirement funds. Otherwise, you may actually trigger unnecessary taxation and lose the ability for the trust beneficiaries to “stretch” their distributions as long as the law allows.

Required Minimum Distributions (RMDs). Your retirement plans have rules about when you must begin taking distributions, known as required minimum distributions. For accounts like a 401(k), you are must start taking RMDs at age 70½. However, if you die and leave retirement plans and accounts to your heirs, the rules apply to them, and they can get pretty complicated. A spousal beneficiary can roll over retirement funds (tax-free) into his or her own retirement plan and make their own distribution choices. However, other beneficiaries don’t have the same option. Learning how the tax treatment and distribution options vary based on who’s receiving your retirement assets is a crucial part of the overall estate planning process.

In addition, some beneficiary designations may qualify for the stretch IRA provision. This lets them withdraw their inherited retirement plan assets over the course of their lifetime—or they may be required to withdraw the entire balance within five years of your death. Who your beneficiary is and determining what distribution rules apply to that person, can make a big difference in how much of your retirement assets are actually passed on to your intended beneficiaries.

Taxes. The biggest worry to address when designating retirement accounts as part of your estate plan is how they’ll be taxed. Retirement accounts are some of the most heavily taxed assets you can pass on after your death. When reviewing your financial and estate plans, find out how you can withdraw from these accounts while you’re alive and how to minimize tax consequences after you’re gone.

The overall goal is to create an estate plan that has the least adverse tax consequences. An estate planning attorney can help you gain a clearer understanding of both the legal requirements of your estate plan and how to ensure that your retirement accounts are distributed in the most tax efficient manner.

Reference: Investopedia (August 27, 2018) “Include Your Retirement Accounts in Your Estate”