In my experience, once you've signed your foundational estate planning documents, choosing the right beneficiaries for your IRAs and 401(k)s is just as important as getting the appropriate legal documents in place. Only you and your estate planning attorney can determine the right beneficiaries in your situation, but here are some things to consider if you're married when updating the beneficiaries of your accounts to coincide with your overall estate planning goals.
Are you in your first marriage?If so, then your spouse is the logical and most tax favored primary beneficiary of your IRAs and 401(k)s. Why? Because your spouse can elect to treat your accounts as their own or roll over your accounts into their own accounts. And why is this so beneficial to your spouse? Because your spouse will be able to stretch out the required minimum distributions ("RMDs") over their own life expectancy, thereby minimizing your spouse's future income tax bills. It will also allow the beneficiaries your spouse names to stretch RMDs over their own life expectancies instead of your spouse's. Aside from this, for 401(k)s and in states that offer creditor protection for IRAs, your retirement accounts will remain creditor protected for your spouse.
Do you have a taxable estate?Then you'll need to balance the benefit of minimizing estate taxes with the benefits listed above for leaving your accounts directly to your spouse. On the one hand, if an account is left to the AB Trusts set up for your spouse in your Revocable Living Trust or Last Will, then this will allow for the efficient use of your estate tax exemption. But on the other, it will result in accelerated income taxes for your spouse and will force the beneficiaries named after your spouse to take RMDs over your spouse's life expectancy, not their own. This will result in the account being liquidated and taxed over a shorter time period if your final beneficiaries are younger than your spouse - your children or grandchildren, for example.
Are you in a second or later marriage?If your goal is to provide for your spouse during his or her lifetime but ultimately leave your estate to your own children or other beneficiaries, then the AB Trusts set up for your spouse in your Revocable Living Trust or Last Will are the logical choice for your primary beneficiary. The downside to this is discussed above - if your children or other beneficiaries are younger than your spouse, then they'll lose the ability to stretch RMDs out over their own life expectancies. Another problem is that for 401(k)s, and IRAs if you live in a community property state, your spouse will need to consent to a primary beneficiary other than your spouse, and if you don't have a prenuptial agreement, then your spouse may refuse to sign the consent.
Are you charitably inclined?If so, then retirement accounts are an excellent choice for meeting your charitable goals. Why? Because not only will IRAs or 401(k)s left directly to a charity create a charitable deduction for your estate and reduce your estate tax bill, but in addition the charity will avoid payment of income tax on the gift received. On the other hand, individual beneficiaries must include IRA and 401(k) distributions in their ordinary income. You can also leave your IRA to a charitable remainder trust for the benefit of your spouse or other beneficiaries. This will provide a steady stream of income to your beneficiaries for a specific number of years or for their remaining lifetimes and create a corresponding charitable deduction for your estate.
Do you want to create a legacy for your family?If your beneficiary designations are structured properly and your Revocable Living Trust or special "IRA Trust" contains the appropriate provisions, then you can create a lasting legacy with your retirement accounts for many generations to come through the use of a Dynasty Trust. This will include maximizing lifetime stretch out of RMDs, protecting beneficiaries at each generation from bad decisions, creditors, lawsuits and divorcing spouses, and minimizing or even eliminating estate taxes at each generation.
Do you want to provide creditor protection for your beneficiaries?Is your spouse bad with money, or what if spouse remarries after you die? Are any of your other beneficiaries bad with money, in a bad marriage, or in a high risk profession? You can protect your spouse by naming the AB Trusts as primary beneficiaries, and you can protect other beneficiaries by naming lifetime trusts created under your Revocable Trust as beneficiaries in place of the individuals. However, check with your estate planning attorney to insure that your Revocable Trust allows for each trust beneficiary to stretch RMDs out over their own life expectancy, otherwise the life expectancy of the oldest beneficiary will be used. You should also consider creating a special "IRA Trust" for the benefit of your beneficiaries.