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Beneficiary Designations
The distribution of retirement accounts upon your death is determined by the beneficiary designation filed with the custodian. Unless your estate is specifically named as the beneficiary—which is generally not recommended—these assets will not be distributed according to your will. As a result, retirement assets may be transferred differently compared to assets governed by your will. A comprehensive estate plan should address the best strategies for assets that pass outside your will, in addition to those that pass through it.
Tax Considerations
Retirement assets require careful planning due to complex rules and tax implications. With traditional IRAs and 401(k) plans, income tax is owed as funds are withdrawn. You pay the tax as you withdraw the assets, and your beneficiaries pay the tax as they withdraw. Thoughtful planning can help extend the period over which withdrawals are made, delaying the tax bill and allowing the assets to grow tax-deferred longer.
Retirement Assets After Death
The following are some considerations in planning for IRAs and similar retirement assets:
- Timing of Withdrawals. The rules for beneficiaries differ significantly from those for the original account holder. Except for options available to a spouse, younger beneficiaries cannot delay withdrawals until their 70s. In many cases, the entire account must be withdrawn within 10 years following your death.
- Minor Beneficiaries. Naming a minor child as a beneficiary typically requires a court-appointed conservator to manage the assets until the child turns 21, which can be costly and involves ongoing court reporting. A more practical approach is to leave the assets to a trust for the child, especially if the trust is drafted in compliance with retirement asset rules.
- Trusts. In certain cases, naming a trust as the beneficiary—such as a trust for minor children—can be beneficial. The structure of the trust dictates how quickly assets must be withdrawn and what happens to those assets once they are paid into the trust. For example, a “see-through trust” for your minor child can qualify as a “designated beneficiary,” allowing withdrawals to be stretched until age 31. If the trust does not qualify, the entire account usually must be withdrawn within 5 years. The “designated beneficiary” rules are complex, and a trust must be carefully drafted in order to qualify as a “see-through” trust.
- Estate. Naming your estate as the beneficiary provides the fewest options for delaying withdrawals. If your estate is named, the account generally must be withdrawn within 5 years of your death. To avoid keeping your estate open for an extended period, it may be more practical to withdraw the entire account in a lump sum which, unfortunately, does result in all of the income tax due at once.
- Spouse. If your spouse is named as beneficiary, your spouse will have several options, including rolling the account into their own IRA and selecting their own beneficiary. This arrangement works well for many couples, but is problematic if you want to control who receives the balance of the retirement account after your spouse’s death.
- Charities. Naming a charity as the beneficiary of a retirement plan is a good choice if you wish to benefit a charity upon your death. Assets left directly to a charity pass free from income tax.
The Power of Planning
Planning for retirement accounts is a key part of an effective estate plan. The estate planning attorneys at Lyons Gaddis can help you design a plan that addresses all your assets, including retirement accounts, to ensure that everything you have worked hard to build passes according to your wishes.
This publication is designed to provide general information. It does not constitute legal or financial advice.
