Planning with Retirement Benefits

After the will or trust has been signed, there’s still some more work to do to complete estate planning.  Assets that pass by beneficiary designation, such as life insurance and retirement accounts, should be reviewed to insure that the correct beneficiaries have been named. 

With the decline of employer-sponsored "defined benefit" (pension) plans, most people accumulate a significant amount of money in "defined contribution" plans that include 401(k), 403(b), 457, TSP and traditional, Roth and SEP IRAs.  Beneficiary designations affect not only who gets the assets, but how quickly funds must be withdrawn from the account.

Wendy Goffe, an estate planning attorney from Seattle recently posted an article on Forbes Magazine online that highlighted the problems that can occur if beneficiary designation are incorrect and offered some pointers to avoid mistakes that can carry severe penalties with IRS:

  1. “Name a primary beneficiary (or beneficiaries).
  2.  Name an alternate beneficiary in case the first one dies before you.
  3. Don’t name your estate as the beneficiary.
  4. Review these forms once a year to make sure they still carry out your wishes.
  5. Update your forms more often if there has been a change in your life circumstances, such as a birth, adoption, marriage, divorce or death.
  6. Each time you change the form, send it to the financial institution that holds the account, and ask them to acknowledge receipt.”

If these simple steps are ignored, what will happen?

No beneficiary form on file with the institution or the named beneficiary has predeceased means there is no named beneficiary.  Each company has its own policies on how the account will be distributed if there is no named beneficiary.  There is no way to predict what a company’s policy will be; sometimes it defaults to the surviving spouse or surviving children if there is no spouse.  The estate of the deceased frequently is the default recipient of the account.

IRAs that have a “designated beneficiary”, in IRS terms, receive the most favorable income tax treatment of being able to take only the minimum required distributions (MRD) from an inherited retirement account each year.   The younger the beneficiary, the longer the account can grow tax deferred (or tax free in the case of a Roth IRA).  This is known as “stretching out” an IRA.  A designated beneficiary must be a human with a life expectancy.  Unfortunately, an estate does not have a life expectancy. There are complicated rules regarding how quickly a retirement account must be paid out when there is no designated beneficiary.  Generally stated, it must be completely distributed over five years.  If the original owner died before reaching 70 ½, the new account owner can continue the MRDs for the original owner’s life expectancy.

Naming minor children as beneficiaries can create additional complications, including the need to have a court name a guardian to manage the account for benefit of the minor child.  It is usually preferable to create a trust within a will (testamentary trust), a revocable trust or even a stand-alone retirement plan trust as the designated beneficiary.  It is still necessary to name the trust on the beneficiary designation form.