Have You Reviewed Your IRA, 401(k) or Other Retirement Plan Beneficiary Designation?
Retirement plans are generally like life insurance because plan benefits generally have a designation of a beneficiary. When a beneficiary is designated the payment of benefits pass outside of your will to the person or persons designated. The retirement plan beneficiary designation form is one of the most overlooked by plan participants. If you have not reviewed your beneficiary designation lately, it is recommended you do so with an experienced estate planning attorney in conjunction with your overall estate planning.
Who or What May be a Designated Beneficiary?
While some plans may name beneficiaries for you (i.e. your spouse, then your children, and then your estate) many plans will allow you, as the participant, to name a “Designated Beneficiary” (“DB”), Designated Beneficiaries (“DBs”), Contingent Beneficiary and Beneficiaries or Secondary Beneficiary or Beneficiaries. If you name more than one beneficiary, most plans will require you to designate the specific distribution you desire such as 50% or 25%. Contingent or secondary beneficiaries will receive the proceeds, in the amount you designate, if your primary designated beneficiary or beneficiaries pre-decease you.
What Happens if You Don’t Designate a Beneficiary?
If you fail to name a DB many plans will designate a DB for you such as your spouse, your children, or your estate. A “Designated Beneficiary” (“DB”) is a term defined in the Internal Revenue Code. If there is no DB the payout options of your retirement plan benefits, and taxation of them, will generally be much less favorable than if there is a DB.
What Does Having a DB Mean for the Beneficiary?
Having a DB means that upon your death, the DB or DBs will receive the funds in your plan, in such proportions if more than one DB is named, as you designate. This also means that upon receipt of the funds the DB will be subject to the tax implications of receiving those funds. There are many rules and options for spouse and non-spouse beneficiaries to consider when receiving money from a retirement plan that could have significant tax implications for them.
Spouse Beneficiaries
If you name your spouse as your DB, your spouse can receive the designated portion as a lump sum, penalty-free, but not tax free. The IRS generally taxes lump-sum distributions as ordinary income. Your spouse may be able to “roll over” the distributions received, tax free, to another retirement plan. In the case of a 401(k) and IRA, your spouse may elect to treat it as her own, which has the same effect as a “tax free” roll over. If the original account owner had already started taking required minimum distributions (RMDs), the spouse may choose to continue taking RMDs or roll over the 401(k) into an account in their name, and wait until they turn 73, the age when RMDs begin.
Non-Spouse Beneficiaries
Non spouse beneficiaries can also receive their portion of a 401(k) account as a lump sum, again, penalty-free, but not tax free.
Non spouse beneficiaries can also do a direct trustee-to-trustee transfer of inherited 401(k) funds into an inherited IRA. The inherited IRA is established for the specific purpose of receiving the distribution from the plan in the name of the deceased participant and payable to the DB. It is important to note the following about non spouse inherited IRAs:
- This transaction must be done by direct roll over only to the inherited IRA. It is not permissible for the DB to take a distribution from the plan and then place the distribution in an inherited IRA.
- If certain rules are followed, a trust maintained for one or more DBs is treated as a DB for purposes of establishing the direct roll over inherited IRA.
- The non spouse beneficiary can’t make additional contributions to an inherited IRA.
- Unlike a spouse beneficiary who has a more flexible schedule to empty an inherited IRA, certain non spouse beneficiaries will need to withdraw all funds in an inherited IRA opened after January 1, 2020, no later than 10 years after the original account owner’s death.
- IRS regulations require RMDs during the 10-year period to be taken at least as often as they would have been taken under the original owner’s remaining life expectancy.
- The penalty for not emptying the account within ten years is 25% of the remaining account balance, which can be reduced to 10% if corrected within two years.
There are exceptions to these rules for some non spouse beneficiaries including a minor child of the account owner, someone who is disabled or chronically ill, or a beneficiary who is not more than 10 years younger than the original IRA owner.
The lessons to be learned from the many rules and exceptions noted above is that you should review and discuss the implications of your retirement plan beneficiary designations with an experienced PK Law Estate Planning Attorney. They can provide guidance on how these designations will fit into your overall estate plan which should include making sure your beneficiaries are aware of your designations and understand the implications.
A PK Law Estate Planning Attorney can assess your assets and evaluate your unique circumstances and wishes with regard to your estate plan and ensure the necessary steps are taken and the necessary documents are in place for your estate plan.