Getting Your Affairs in Order: It's Not Just About a Will
The growing prevalence and value of 401(k) plans and IRAs, and other retirement accounts have become more significant portions of many estates – and they generally are not governed by a will. The distribution of retirement accounts is governed, instead, by Beneficiary Designations signed by the account holder and delivered to the account custodian. These accounts need special consideration not just for retirement planning but also for their place in any estate planning. It is important to have a will for the proper settlement of an estate, but it is equally important to have well-planned Beneficiary Designations for each retirement plan.
Deferrals or Deductions?
Traditional IRAs and 401(k) plans allow taxpayers to defer income taxes on current income for contributions made to the plan accounts. While many people think of such savings as tax deductions, the deductions are, in reality, merely tax deferrals. The tax does not go away; it will become due when the money is withdrawn from the account. Withdrawals are treated as ordinary income (not capital gains) based on the full value of the withdrawals, no matter who ultimately makes the withdrawal.
The retirement plan owner may name a Primary Beneficiary, who will receive the balance of the plan assets upon the death of the account holder, and Contingent Beneficiaries, who will each receive their stated share of the balance should the Primary Beneficiary die before the account holder. The Designated Beneficiary form should be reviewed whenever creating or reviewing an estate plan, and whenever there is a death or change in circumstances for one of the beneficiaries.
Account holders frequently name a surviving spouse as the Primary Beneficiary and children in equal shares as the Contingent Beneficiaries. This arrangement allows a surviving spouse to roll over the account into a Spousal IRA, which provides continued deferral of income taxes for the surviving spouse, and the potential for tax deferral for up to ten years for the children if the spouse dies first. A Spousal IRA is treated like the personal IRA of the surviving spouse, who may then name his or her own Primary and Contingent Beneficiaries.
Don't Forget to Update Beneficiaries
If the spouse should need long-term care, then it may no longer be wise to name that spouse as the beneficiary of any retirement plan. If a nursing home looks imminent, then retirement plan designations should be reviewed and probably changed as a prominent and early part of the long-term care planning process. The healthy life expectancy of any beneficiary should be considered whenever making any Designation of Beneficiary.
Naming Charities as Beneficiaries
An account holder should consult with an experienced attorney or accountant before naming a charity of any retirement plan. Naming a charity as the Designated Beneficiary of a percentage of a retirement plan will destroy the tax deferral for all other beneficiaries of that plan. If you want to make a gift to a charity in your estate plan, you should do so in a will or trust, or make lifetime gifts.
If most of your assets are in retirement plans, you may create a separate IRA with a portion of your retirement plans. The separate account can be used solely for designating a charity, but use extreme caution in doing so, and seek the advice and guidance of a tax professional.
What Happens if No Beneficiary is Named?
If you have not delivered a signed Designated Beneficiary form to the retirement plan custodian, or if none of the named beneficiaries survive you, then the assets of the plan will be distributed in accordance with the rules of each individual plan. Some plans direct that the assets be transferred to your estate, to be distributed in accordance with your will or the laws of intestacy. Other plans set out their own line of succession, determining which of your heirs receive the assets. In any event, if there is no surviving Designated Beneficiary, there will be no further deferral of income taxes which must be paid by your estate or the recipients of your plan assets.
Your estate planning attorney at Kahan Kerensky Capossela will review your retirement plans as part of your estate planning process. If you have further questions concerning your beneficiary designations, even without a full estate plan review, we would be happy to assist you. Contact our Estate Planning Coordinator, Eva Holmes, at 860-812-1737 or firstname.lastname@example.org to set up an appointment.