A large percentage of American workers have a retirement account of some
sort, whether it’s an IRA or a 401(k), therefore, it’s important
to know how to properly plan for these assets in one’s estate planning
documents. From taxes to beneficiary designations, you need to know how
your retirement account is distributed when you pass.
Are beneficiaries taxed on retirement assets passed to them?
More than likely yes, they will be taxed. Retirement accounts are considered
income for the deceased, so whenever a beneficiary withdraws from a non-Roth
account, the withdrawal will be subject to the beneficiary’s usual
income tax rate.
Should my spouse be my beneficiary?
It’s up to you, but most married people will designate their spouse
as their primary beneficiary and then their children will be the contingent
beneficiaries. If you’re going to take this approach, make sure
that your beneficiary designations take into account your broader estate
planning goals.
Another approach is to leave your retirement account to a trust, which
can benefit those closest to you, such as your spouse, children and grandchildren,
other family members, close friends or favorite charities.
Why is a trust beneficial?
When you pass down retirement accounts to beneficiaries through a trust,
you benefit from more flexibility. When a trust is designed to receive
a retirement account, the trust allows the retirement account balance
to continue growing indefinitely, all tax-deferred.
Also, the trust protects the retirement account from beneficiary creditors,
and it allows the beneficiaries to receive the asset in strict accordance
with the decedent’s wishes.
Are 401(k)s and IRAs treated the same?
No, they are not the same. If a decedent leaves behind an employer-sponsored
plan, such as a 401(k) or a pension, the beneficiary will experience more
limitations and restrictions than someone who inherits an IRA.
For example, an employer-sponsored plan, such as a 401(k), will usually
require that the money be withdrawn from the account within five years
of the decedent’s death. Additionally, any money withdrawn from
a beneficiary will be subjected to income tax.
With an IRA on the other hand, the beneficiary doesn’t have to cash
in by any set date. If the beneficiary so pleases, they can keep it for
however long they want, effectively continuing the tax-deferred growth.
If you are interested in customizing an estate plan that addresses your
retirement assets, please contact an estate planning attorney to ensure
that everything is handled correctly, and according to your wishes.