Reviewing beneficiary choices

If you can’t remember the last time you checked the beneficiary designations for your employer-sponsored retirement plans and IRAs, a review is probably overdue. You may decide to make no changes. But factors that influenced your earlier selections may no longer apply. Perhaps you’re no longer married or you’ve married again. Or perhaps a charitable organization you wanted to benefit has dissolved.

There may be other good reasons for reconsidering your beneficiary designations, particularly if your financial goals include extending the tax-deferred status of your retirement plan assets as long as possible, reducing potential estate taxes, and sharing your wealth more broadly than you had previously planned.

 Naming names

You’re free to name any person, charitable organization, or trust as the primary beneficiary of a retirement plan, with one exception: Federal law requires that your spouse be the beneficiary of your 401(k) and similar employer-sponsored retirement savings plans. Your spouse must consent if you want to name another beneficiary or beneficiaries and must file a signed and notarized waiver with the plan administrator. The same protection does not extend to a domestic partner.

If you have children but no spouse and want to name them as beneficiaries, there can be complications if they haven’t reach the age of majority in your state. Most plans will not transfer assets directly to minors. So it may be wise to establish a trust that qualifies with the IRS as a designated beneficiary and then name the trust as beneficiary. As the children grow older, you can always designate them directly as beneficiaries if you’re comfortable with their ability to handle the money. Remember, though, if you set up one trust and there are several beneficiaries, it’s the age of the eldest child that will govern the amount of the required annual distribution after your death.

You have the same beneficiary options with an IRA as you do with other retirement plans, but without the requirement to name your spouse as beneficiary or obtain a waiver. In fact, one reason some people choose to roll over their employer plan assets into an IRA when they change jobs or retire is to create more flexibility in sharing their assets.

One approach to avoid is naming your estate as beneficiary. That’s because, if the designation sticks, all assets must be withdrawn from the retirement plan within five years after the year of your death. That generally means higher income taxes for your heirs with none of the potential tax benefits that might result from stretching out the life of the account. This approach also subjects the assets in the plan or IRA to probate, which wouldn’t otherwise be the case.  

Contingent Beneficiaries

Since there’s always the possibility that the person you’ve named as primary beneficiary will not survive you, even if he or she is younger, it’s also important to name contingent, or secondary, beneficiaries who would be next in line for the assets. If you’re married and have children, a typical approach is to name the children as contingent beneficiaries, though you might make a different choice. For example, you might consider naming one or more of your grandchildren or a trust established in their names as beneficiaries in order to extend the tax-deferred status of the account.

Since naming beneficiaries two or more generations younger than you are could trigger the generation-skipping transfer tax, however, you’ll want to discuss the pros and cons of this approach with your tax and legal advisers. There is an exemption, but you don’t want to risk added taxation.

You might also name a charitable organization as the contingent beneficiary if that choice fits into your overall estate plan.

Enjoying the Benefits

All beneficiaries are not created equal however, in terms of the way they must take the required distributions from an employer plan or IRA. And all plans don’t have identical provisions or practices. So it makes sense to know what your beneficiaries can expect so you can provide guidance on their choices.

Your spouse has the most options, including rolling over the assets in your employer plan or IRA into an IRA in his or her own name, a choice that isn’t available to any other type of beneficiary. When an account is rolled over, additional contributions are permitted, new beneficiaries can be named, and required distributions based on the new owner’s life expectancy will apply. This may mean, for example, being able to postpone withdrawals for a number of years, typically until after the new owner turns 70 ½.

Your spouse can also treat your retirement plan account or IRA as an inherited asset. In that case, he or she must start making withdrawals by the end of the year following the year of your death. The amount of the annual required withdrawal is generally determined by your spouse’s age at the time the withdrawals begin. The final alternative is a lump-sum withdrawal by the end of the fifth year after the year you die. While, in some cases, this may be a good choice, it’s generally not.

If you name another person as beneficiary, he or she inherits your IRA and must begin to take annual withdrawals from the inherited IRA or plan, beginning no later than the end of the year following the year you die. The withdrawal amount is determined by the account balance at the end of the year and the beneficiary’s age. The lump-sum withdrawal is also available and may be required in the case of an employer plan.

Making the best choices — both of beneficiaries and by beneficiaries — can be difficult. But the worst choice of all is not examining your alternatives and making decisions that best meet your intentions and goals.


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