Beneficiary Designation to Your Retirement Accounts: Who Should You Choose?

Dana Brewer, CFP®
Jun 19, 2019 2:47:30 PM

beneficiary designation to your retirement accountsYour retirement account(s) may be some  of your largest assets so it is important to choose wisely. Upon death, your retirement account(s) likely pass directly to the beneficiaries you have named, which means they don’t typically flow through your will. This is important to understand especially if you have named beneficiaries that you may feel are not ready to make good money decisions yet or ever. Even if your will has made provisions for the beneficiaries in your life that are not ready to handle the inheritance, the retirement account will bypass the will and pass the assets directly to those unprepared beneficiaries you have elected.  

Factors to Consider

  • The IRS has regulations that dictate different payout options for different types of beneficiaries. For example, Retirement plans can typically move to a spouse without any requirement to take money out before the spouse would normally be required (at age 70 ½). If the same account transfers to a non-spouse there will be some requirement to make some distributions and pay the corresponding taxes on the money they receive.
  • Children – are they ready now or ever to handle this kind of money?  If not, you may want to work with an estate attorney to discuss the pros and cons of adding some controls to how and when the kids will inherit.  
  • Second Marriage – Is this a second marriage and are there any kids from the prior marriage? Do you want any of the account to go directly to the kids from the 1st marriage or does all of the account go to your current spouse?
  • How inherited assets are treated after your death – A good reminder that inheritances in certain situations may become joint property with the spouse of your beneficiary. In the event a divorce takes place, part of that inheritance could in fact be divided.

A trust may be a tool recommended by your estate attorney to assist in solving some of the factors you may be considering. There are pros and cons to every tool and it is essential to understand the trade offs.

Types of Beneficiaries

  • Primary beneficiary is a person/entity who will inherit the retirement account as long as they are alive when the owner dies.  
  • Contingent beneficiary is in most cases a person/entity who receives the retirement account if the primary beneficiary was not alive when the retirement account owner dies, or if the primary beneficiary disclaims the assets.  
  • If no beneficiary is named or living, most retirement plan documents provide that the assets will be paid to your estate but it is important to check your plan document. Better yet, make sure you have named your beneficiaries and check them with some regularity to make sure they still reflect your plan.

What is a Stretch IRA?

Congress is currently considering new retirement legislation that could potentially change the items below if it is signed into law. To learn more: Highlights of a House Bill’s Attempts to Help Retirees and Savers

  • A stretch IRA is a process not a product. It refers to the ability of a beneficiary of a retirement account to spread the distributions over the beneficiaries’ life expectancy. By taking the smallest amount required each year the beneficiary allows the money to grow tax-deferred inside of the retirement account.  
  • If there are multiple beneficiaries each beneficiary may stretch out distributions over her/his own life expectancy if separate accounts are established for each by the deadline. When inherited by a non-spouse they are typically referred to as inherited IRA’s. The rules for how much needs to come out each year are complicated and it is best to work with a financial advisor or custodian to determine the required minimum distribution (RMD).  
  • Spouse beneficiaries typically transfer the account to a spousal IRA and can, but are not required to, delay taking RMD distributions until they are 70.5 allowing the money to grow tax deferred. Spouses over 59.5 have unlimited right to withdrawal from the IRA without penalty but like all IRA withdrawals the money is taxable at the time you make the distribution.

There are many additional rules and considerations involved in making the beneficiary decision. Consulting a professional is essential to make sure your intent is reflected in your beneficiary election as well as when your beneficiaries inherit.  Whenever there are changes in your life such as – a new marriage, divorce, birth of a child or grandchild, death of a beneficiary or changes to the tax law we advise consulting with your financial and legal advisors. The federal tax regulations governing retirement account are complicated with rules that vary for distributions from your own accounts versus ones you inherit and on top of that the rules get changed from time to time. Staying on top of your plan is essential.

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