NOTE: State laws change frequently and the following information may not reflect recent changes in the laws. For current tax or legal advice, please consult with an accountant or an attorney since the information contained in this article is not tax or legal advice and is not a substitute for tax or legal advice.
If you have any of your assets held in a qualified retirement plan, such as a 401(k) or IRA, then before updating your beneficiary designations to compliment the terms of your estate plan, you will need to consider the following factors.
Does your Revocable Living Trust contain the appropriate provisions?
Beware: not all Revocable Living Trusts
contain provisions for accepting retirement accounts as trust assets. If you are considering naming your trust as the beneficiary of your qualified retirement plans, then it must contain specific language that gives your successor Trustee
the flexibility needed to make appropriate tax elections and to allow required minimum distributions
, or RMDs, to be stretched out over the lifetimes of your beneficiaries. If the appropriate language is not in the trust agreement and you designate it as the beneficiary of your IRA, then your beneficiaries will be required to withdraw all of the funds out of the account in as little as five years after your death instead of over their own life expectancies.
Does your 401(k) allow for RMDs to be stretched out?
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Beware: many 401(k)s, 403(b)s, and other types of employer provided retirement plans invoke the five-year rule and require that all of the funds left in an account when an employee or former employee dies be withdrawn within five years after the employee's death. This is because employers do not want to be in the business of administering an account for the benefit of a deceased employee's beneficiaries for many years into the future. If you still have assets held in a 401(k) or other type of qualified retirement plan with a former employer and are not concerned about creditor issues, then consider rolling the assets over into an IRA. This will offer your beneficiaries the flexibility of stretching RMDs out over their own life expectancies instead of being forced to withdraw all of the funds in as little as five years.
Are you concerned about protecting your beneficiaries?
Many states offer creditor protection for assets held in IRAs and the federal government offers the same type of protection for 401(k)s. But what happens when the account owner dies and the retirement assets are distributed directly to a beneficiary? In June 2014 the U.S. Supreme Court held that once the retirement assets pass to an individual beneficiary, they lose their creditor protection and will be immediately accessible to the creditors of the beneficiary. If you want to provide creditor and divorce protection for your beneficiaries, then consider leaving the retirement plan assets to a discretionary lifetime trust
or to a special IRA Trust
for the benefit of the beneficiaries instead of outright.
Is your intended beneficiary a minor?
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If the beneficiary of your IRA or 401(k) is a minor when you die, then the beneficiary will not be allowed to legally accept the assets and so a court-supervised guardianship or conservatorship
will need to be established for the minor. Then, when the minor reaches 18 or 21 (depending on applicable state law), the beneficiary will gain complete control over the remaining retirement assets. Instead, you should consider designating the separate share trust created for the minor in your Revocable Living Trust
or a separate IRA Trust
as the beneficiary. In addition, you will need to take into consideration generation skipping transfer taxes
if the beneficiary is a grandchild, or, if the beneficiary is not related to you, then more than 37 1/2 years younger than you.
Do you have a taxable estate?
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If you have a taxable estate
and a significant amount of your assets are in a qualified retirement plan, then these assets should be the last place for you to look when figuring out how the estate tax bill will be paid
. This is because the retirement plan assets will not receive a step up in basis
, and so any amount withdrawn from a qualified account will be subject to income taxes. Instead, you should look to cash or life insurance to pay the estate tax bill since these assets will not generate any income taxes, or even stocks or real estate since these assets will receive a step up in basis and so the income tax consequences of a sale will be minimized.
Are you married and have a taxable estate?
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For married couples who cannot rely on portability
to maximize their estate tax exemptions
, retirement plans should be the last place for them to look to fund the AB Trusts
created for the benefit of the surviving spouse in their Revocable Living Trusts
. The reasons why are complicated but mainly tie in to income tax considerations and maximizing options for the beneficiaries named after the surviving spouse dies. In addition, many Revocable Living Trusts do not contain the appropriate language to administer IRAs left to an A or B Trust. Only you, your spouse, and your estate planning attorney can determine when and if your retirement plans should be named as the primary beneficiaries of the AB Trusts created in your Revocable Living Trust.