How 401(K) Beneficiaries Work

September 28, 2020

For anyone who thinks that their will or trust can be used to distribute assets in a 401(k) after they pass, think again. It is important to understand how 401(k) beneficiaries work with your estate plan. The beneficiaries listed in a 401(k), insurance policy or any account with the option to name a beneficiary supersede whatever directions are placed in a will or a trust. If you’re not careful, warns the article “What You Should Know About 401(k) Beneficiaries” from The Motley Fool, your assets could end up in the wrong hands.

Here are some basics about beneficiaries that you need to know.

After you die, your estate goes through probate, which can be a costly and lengthy process. However, assets like 401(k) plans that have named beneficiaries are typically passed to heirs outside of probate. The asset goes directly to the beneficiary.

When you opened a 401(k), you were almost certainly directed to name a beneficiary in the paperwork used to establish the account. That person is usually a spouse, child or a domestic partner. The beneficiary is sometimes a trust (a legal entity that manages assets for the benefit of beneficiaries).

If no beneficiary was named and you were married when you established the account, most 401(k) plans designate your spouse as the default beneficiary. The surviving spouse is allowed to treat the account as if it is their own when they inherit it—they can delay withdrawing money until they are 72, when the IRS requires withdrawals to begin. The surviving spouse uses their own life expectancy, when calculating future withdrawals.

If someone other than a spouse was listed as the beneficiary, the assets are to be transferred into an inherited 401(k) and the amounts received are based on the percentage listed on the beneficiary designation form. Most plans give the beneficiaries the option to roll over an inherited 401(k) into an inherited IRA. This gives the account owners greater control over what they can do with their inheritance.

Once you have named a beneficiary on these accounts, it’s wise to list contingent beneficiaries, who will inherit the accounts, if the primary beneficiary is deceased. For most families, the children are the contingent beneficiaries and the spouse is the primary beneficiary.

The list of mistakes made when naming beneficiaries is a long one, but here are a few:

Setting up a trust to keep IRA or 401(k) assets from going to a minor or to protect services for a special needs child, then failing to list the trust as a beneficiary.
Not naming anyone as a beneficiary on an IRA or 401(k) plan.
Neglecting to check beneficiary names every few years or after big life changes.

If you set up a trust for your beneficiaries, you must list the trust as the beneficiary. If you don’t specifically list the trust, the account will pass to any person listed as a beneficiary, or the accounts will go through probate.

If you have had more than a few jobs and have more than a few 401(k) accounts, it can be challenging to track the accounts and the beneficiaries. Consolidating the accounts into one 401(k) account makes it easier for you and for your heirs.

If you do list a trust as a beneficiary, talk with your estate planning attorney about how to do this correctly. The trust’s language must take into consideration how taxes will be handled. This could have big costs for your heirs.

If you would like to learn more about beneficiaries, please visit our previous posts.

Reference: The Motley Fool (Aug. 24, 2020) “What You Should Know About 401(k) Beneficiaries”

What is an Eligible Designated Beneficiary?

August 27, 2020

What is an eligible designated beneficiary? An eligible designated beneficiary (EDB) is a person included in a unique classification of retirement account beneficiaries. A person may be classified as an EDB, if they are classified as fitting into one of five categories of individuals identified in the Setting Every Community Up for Retirement Enhancement (SECURE) Act. The bill passed in December 2019 and is effective for all inherited retirement accounts, as of the first of this year.

Investopedia’s recent article explains that these people get special treatment and greater flexibility to withdraw funds from their inherited accounts than other beneficiaries.

With the SECURE Act, there are now three types of beneficiaries. It is based on the individual’s connection to the original account owner, the beneficiary’s age, and his or her status as either an individual or a non-person entity. However, an EDB is always an individual. On the other hand, an EDB can’t be a trust, an estate, or a charity, which are considered not designated beneficiaries. There are five categories of individuals included in the EDB classification. These are detailed below.

In most instances, except for the exceptions below, an EDB must withdraw the balance from the inherited IRA account over the beneficiary’s life expectancy. There is optional special treatment allowed only for surviving spouses, which is explained below. When a minor child reaches the age of majority, he or she is no longer considered to be an EDB, and the 10-year rule concerning withdrawal requirements for a designated beneficiary applies.

Here are the five categories of eligible designated beneficiaries.

Owner’s surviving spouse. Surviving spouses get special treatment, which lets them step into the shoes of the owner and withdraw the balance from the IRA over the original owner’s life expectancy. As another option, they can roll an inherited IRA into their own IRA and take withdrawals at the point when they’d normally take their own required minimum distributions (RMDs).

Owner’s minor child. A child who isn’t yet 18 can make withdrawals from an inherited retirement account using their own life expectancy. However, when he or she turns 18, the 10-year rule for designated beneficiaries (who aren’t EDBs) applies. At that point, the child would have until December 31 of the 10th year after their 18th birthday to withdraw all funds from the inherited retirement account. A deceased retirement account owner’s minor child can get an extension, up until age 26, for the start of the 10-year rule, if he or she is pursuing a specified course of education.

An individual who is disabled. The tax code says that an individual is considered to be disabled if he or she is “unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long continued and indefinite duration.” A disabled person who inherits a retirement account can use their own life expectancy to calculate RMDs.

An individual who is chronically ill. The tax code states that “the term ‘chronically ill individual’ means any individual who has been certified by a licensed healthcare practitioner as—

being unable to perform (without substantial assistance from another individual) at least two activities of daily living for a period of at least 90 days, due to a loss of functional capacity,
having a level of disability similar (as determined under regulations prescribed by the Secretary in consultation with the Secretary of Health and Human Services) to the level of disability described in clause (i), or
requiring substantial supervision to protect such individual from threats to health and safety due to severe cognitive impairment.”

A chronically ill individual who inherits a retirement account can use their own life expectancy to determine the RMDs.

Any other person who’s less than 10 years younger than the decedent. This is a catch-all that includes certain friends and siblings (depending on age), who are identified as beneficiaries of a retirement account. This also excludes most adult children (who aren’t disabled or chronically ill) from the five categories of eligible designated beneficiaries. A person in this category who inherits a retirement account is permitted to use their own life expectancy to calculate RMDs.

Reference: Investopedia (June 25, 2020) “There is a New Type of Beneficiary”

Selecting a Beneficiary for My 401(k)

July 15, 2020

What is the best way to select a beneficiary for your 401(k)? WTOP’s article “How to pick a beneficiary for your 401(k) plan” instructs us on how to make certain your 401(k) savings get to your intended heir.

Name a Beneficiary. Designating a beneficiary of your retirement account lets that person receive your financial bequest without the need to access to your will, financial documents, or go through probate. In designating a beneficiary, carefully think about who that will be, just as you would for any other asset you intend to leave to your heirs.
Name Contingent Beneficiaries. A contingent beneficiary will get the assets from the account in the event that all of the primary beneficiaries have died. Review your beneficiary designations at least annually to ensure each beneficiary, and their assigned percentage, is still appropriate.
Update Your Named Beneficiaries After Significant Life Events. When you begin a job in your 20s, you might list your parents or siblings as the beneficiary of your account. However, when you marry, you may change your beneficiary to your spouse. If you want to leave your retirement account balance to your children, you must update your beneficiary form upon the birth of each child, or you might leave the youngest out, if you die unexpectedly.

Divorce or remarriage is another reason to change your beneficiary forms. If you remarry and do not select a new beneficiary, your ex-spouse may get your remaining retirement assets.

Note that beneficiary forms are unique to each 401(k) plan. This means that if you have multiple 401(k) accounts with previous employers, you’ll have to update each one.

You can also consider combining old 401(k) accounts or rolling them over into an IRA to make your beneficiary designations and investments easier to manage.

Many 401(k) plans let you update your beneficiaries online.

Inform Your Beneficiaries About Your Accounts. Your heirs may be required to get in touch with the financial institution to get their inheritance. Tell them where you have accounts, so they know what to expect and can claim your unused retirement funds. Be certain that everyone has the information. That way, there’s no question and access to those funds will be easy.

Reference: WTOP (June 8, 2020) “How to pick a beneficiary for your 401(k) plan”

Using Retirement Funds in a Financial Crisis

July 2, 2020

For generations, the tax code has been a public policy tool, used to encourage people to save for retirement and what used to be called “old age.” However, the coronavirus pandemic has caused many households to begin using retirement funds in a financial crisis. Lawmakers have responded by making it easier to tap these accounts. The article “Should You Tap Retirement Funds in a Crisis? Increasingly, People Say Yes” from The Wall Street Journal asks if this is really a good idea.

This shift in thinking actually coincides with trends that began to emerge before the last recession. People were living and working longer. Unemployment and career changes later in life were becoming more commonplace, and fewer and fewer people devoted four decades to working for a single employer, before retiring with an employer-funded pension.

For those who have been affected by the economic downturns of the coronavirus, withdrawals up to $100,000 from retirement savings accounts are now allowed, with no early-withdrawal penalty. That includes IRAs (Individual Retirement Accounts) or employment-linked 401(k) plans. In addition, $100,000 may be borrowed from 401(k) plans.

Americans are not alone in this. Australia and Malaysia are also allowing citizens to take money from retirement accounts.

Lawmakers are hoping that by using retirement funds now, it may help households prevent foreclosures, evictions and bankruptcies, with less of an impact on government spending. With trillions in retirement accounts in the U.S., these accounts are where legislators frequently look when resources are threatened.

However, there’s a tradeoff. If you take out money from accounts that have lost value because of the market’s volatility, those losses are not likely to be recouped. And if money is taken out and not replaced when the world returns to work, there will be less money during retirement. Not only will you miss out on the money you took out, but on the return, it might have made through years of tax-advantaged investments.

The danger of using retirement funds in a financial crisis is that if these accounts are widely seen as accessible and necessary now, a return to saving for retirement or the possibility of putting money back into these accounts when the economy returns to normal may not happen.

IRA and 401(k) accounts began to supplant pensions in the 1970s as a way to encourage people to save for retirement, by deferring income tax on money that was saved. By the end of 2019, IRAs and 401(k) types of accounts held about $20 trillion in the US.

Boston College’s Center for Retirement Research has estimated that even before the coronavirus, early withdrawals were reducing retirement accounts by a quarter over 30 years, taking into account the lost returns on savings that were no longer in the accounts. For many people, taking retirement funds now may be their only choice, but the risk to their financial future and retirement is very real.

Reference: The Wall Street Journal (June 4, 2020) “Should You Tap Retirement Funds in a Crisis? Increasingly, People Say Yes”

What You Need to Know about Drafting Your Will

July 1, 2020

A last will and testament is just one of the legal documents that you should have in place to help your loved ones know what your wishes are, if you can’t say so yourself, advises CNBC’s recent article entitled, “Here’s what you need to know about creating a will.” In this pandemic, the coronavirus may have you thinking more about your mortality. Here’s what you need to know about drafting your will.

Despite COVID-19, it’s important to ponder what would happen to your bank accounts, your home, your belongings or even your minor children, if you’re no longer here. You should prepare a will, if you don’t already have one. It is also important to update your will, if it’s been written.

If you don’t have a valid will, your property will pass on to your heirs by law. These individuals may or may not be who you would have provided for in a will. If you pass away with no will —dying intestate — a state court decides who gets your assets and, if you have children, a judge says who will care for them. As a result, if you have an unmarried partner or a favorite charity but have no estate plan, your assets may not go to them.

The courts will typically pass on assets to your closest blood relatives, despite the fact that it wouldn’t have been your first choice.

Your will is just one part of a complete estate plan. Putting a plan in place for your assets helps ensure that at your death, your wishes will be carried out and that family fights and hurt feelings don’t make for destroyed relationships.

There are some assets that pass outside of the will, such as retirement accounts, 401(k) plans, pensions, IRAs and life insurance policies.

Therefore, the individual designated as beneficiary on those accounts will receive the money, despite any directions to the contrary in your will. If there’s no beneficiary is listed on those accounts, or the beneficiary has already passed away, the assets automatically go into probate—the process by which all of your debt is paid off and then the remaining assets are distributed to heirs.

If you own a home, be certain that you know the way in which it should be titled. This will help it end up with those you intend, since laws vary from state to state.

Ask an estate planning attorney in your area — to ensure familiarity with state laws—for help learning what you need to know about drafting your will and the rest of your estate plan.

Reference: CNBC (June 1, 2020) “Here’s what you need to know about creating a will”

Utilizing the SECURE and CARES Acts?

June 24, 2020

Are you utilizing the SECURE and CARES Acts in the best way possible? The SECURE Act made a number of changes to IRAs, effective January 1, 2020. It was followed by the CARES Act, effective March 27, 2020, which brought even more changes. A recent article from the Milwaukee Business Journal, titled “IRA planning tips for changes associated with the SECURE and CARES acts,” explains what account owners need to know.

Setting Every Community Up for Retirement (SECURE) Act

The age when you have to take your RMD increased from 70½ to 72, if you turned 70½ on or before December 31, 2019. Younger than 70½ before 2020? You still must take your RMDs. But, if you can, consider deferring any distributions from your RMD, until you must. This gives your IRA a chance to rebound, rather than locking in any losses from the current market.

Beneficiary rules changed. The “stretch” feature of the IRA was eliminated. Any non-spousal beneficiary of an IRA owner who dies after Dec. 31, 2019, must take the entire amount of the IRA within 10 years after the date of death. The exceptions are those who fall into the “Eligible Designated Beneficiary” category. That includes the surviving spouse, a child under age 18, a disabled or chronically ill beneficiary, or a beneficiary who is not more than ten years younger than the IRA owner. The Eligible Designated Beneficiary can take distributions over their life expectancy, starting in the year after the death of the IRA holder. If your estate plan intended any IRA to be paid to a trust, the trust may include a “conduit IRA” provision. This may not work under the new rules. Talk with your estate planning attorney.

IRA contributions can be made at any age, as long as there is earned income. If you have earned income and are 70 or 71, consider continuing to contribute to a Roth IRA. These assets grow tax free and qualified withdrawals are also tax free. If you plan on making Qualified Charitable Distributions (QCD), you’ll be able to use that contribution (up to $100,000 per year) from the IRA to offset any RMDs for the year and not be treated as a taxable distribution.

Coronavirus Aid, Relief and Economic Security (CARES) Act

The deadline for contributions for traditional or Roth IRAs this year is July 15, 2020. The 2019 limit is $6,000 if you are younger than 50 and $7,000 if you are 50 and older.

RMDs have been waived for 2020. This applies to life expectancy payments. It may be possible to “undo” an RMD, if it meets these qualifications:

The RMD must have been taken between February 1—May 15 and must be recontributed or rolled over prior to July 15.
RMDs taken in January or after May 15 are not eligible.
Only one rollover per person is permitted within the last 12 months.
Life expectancy payments may not be rolled over.

Individuals impacted by coronavirus may be permitted to take out $100,000 from an IRA with no penalties. They are eligible if they have:

Been diagnosed with SARS-Cov-2 or COVID-19
A spouse or dependent has been diagnosed
Have experienced adverse consequences as a result of being quarantined, furloughed or laid off or having work hours reduced due to the virus, are unable to work because of a lack of child care, closed or reduced hours of a business owned or operated by the individual or due to other factors, as determined by the Secretary of the Treasury.
Note that these distributions are still taxable, but the income taxes can be spread ratably over a three-year period and are not subject to the 10% early distribution penalty.

Keep careful records, as it is not yet known how any of these distributions/redistributions will be accounted for through tax reporting. All of these tips will allow you to utilize the SECURE and CARE Acts effectively.

Reference: Milwaukee Business Journal (June 1, 2020) “IRA planning tips for changes associated with the SECURE and CARES acts”

Incorrect Beneficiary Designations are Trouble for Heirs

May 27, 2020

There are many account types that are governed by beneficiary designation, such as life insurance, 401(k)s, IRAs and annuities. These are the most common investment accounts people have with contractual provisions to designate who receives the asset upon the death of the owner. Incorrect beneficiary designations are trouble for your heirs.

Kiplinger’s recent article entitled “Beneficiary Designations – The Overlooked Minefield of Estate Planning” provides several of the mistakes that people make with beneficiary designations and some ideas to avoid problems for you or family members.

Believing that Your Will is More Power Than It Really Is. Many people mistakenly think that their will takes precedent over any beneficiary designation form. This is not true. Your will controls the disposition of assets in your “probate” estate. However, the accounts with contractual beneficiary designations aren’t governed by your will, because they pass outside of probate. That is why you need to review your beneficiary designations, when you review your will.

Allowing Accounts to Fall Through the Cracks. Inattention is another thing that can lead to unintended outcomes. A prior employer 401(k) account can be what is known as “orphaned,” which means that the account stays with the former employer and isn’t updated to reflect the account holder’s current situation. It’s not unusual to forget about an account you started at your first job and fail to update the primary beneficiary, which is your ex-wife.

Not Having a Contingency Plan. Another thing people don’t think about, is that a beneficiary may predecease them. This can present a problem with the family, if the beneficiary form does not indicate whether it is a per stirpes or per capita election. This is the difference between a deceased beneficiary’s family getting the share or it going to the other living beneficiaries.

It’s smart to retain copies of all communications when updating beneficiary designations in hard copy or electronically. These copies of correspondence, website submissions and received confirmations from account administrators should be kept with your estate planning documents in a safe location.

Remember that you should review your estate plan and beneficiary designations every few years. Sound estate planning goes well beyond a will but requires periodic review. Incorrect beneficiary designations could create trouble for your heirs after you pass away.

If you would like to read more about beneficiary designations, please visit our previous posts.

Reference: Kiplinger (March 4, 2020) “Beneficiary Designations – The Overlooked Minefield of Estate Planning”

Coronavirus Stimulus allows Retirees to withdraw Money early

May 4, 2020

Coronavirus Stimulus law allows retirees to withdraw money early from tax-deferred accounts without penalties, for a limited time. Rules on taking loans from 401(k)s will also be loosened up, and some retirees will be able to avoid Required Minimum Distributions (RMDs) that otherwise would have been costly, says the article “Coronavirus stimulus lets struggling Americans tap retirement accounts early” from the Los Angeles Times.

In some cases, these changes reflect what has been done for retirement savers in previous disasters. However, for the most part, these are more intense than in other events. The chief government affairs officer of the American Retirement Association, Will Hansen, says that we are now in uncharted territory as a result of the Covid-19 pandemic. The numbers of people filing for unemployment make it likely that many people will be tapping their retirement accounts.

One provision in the bill would allow investors of any age to take as much as $100,000 from their retirement accounts without any early withdrawal penalties. If the money is put back in the account within three years, there won’t be any taxes due. If the money is not put back, taxes can be paid over the course of three years. The law says that the money must be a “coronavirus-related distribution,” but the rules are loose.

People who test positive for the virus, along with anyone who experiences adverse financial consequences as a result of the pandemic, including being unable to find work or childcare, are permitted to make these withdrawals.

The bill also makes it easier to borrow money from 401(k) accounts, raising the limit on these loans from $50,000 to $100,000. The payment dates for any loans due in 2020 are extended for a year.

Retirees in their early 70s were previously required to start taking money out of tax-deferred accounts and start paying taxes on those distributions. The bill also waives these rules.

U.S. individual retirement accounts held nearly $20 trillion in assets at the end of 2019. While those amounts have certainly dropped due to market volatility, Americans still hold a lot of money in retirement accounts.

However, pre- and post-retirees need to think carefully about withdrawing large sums of money now. For pre-retirees, this should only be a last resort. Some professionals think the 401(k)-loan amount is too high and that people will jump to take out too much money, which will never find its way back.

According to a U.S. Government Accountability Office report from 2019, Americans ages 25-55 take approximately $69 billion a year from their retirement accounts. Once the money is gone, it’s not able to earn future tax-deferred returns.

If you are interested in learning more about the new stimulus law, please visit our previous posts.

Reference: Los Angeles Times (March 27, 2020) “Coronavirus stimulus lets struggling Americans tap retirement accounts early”

Update Your Plan to Protect Spouse and Children

April 22, 2020

Without an updated estate plan, a surviving spouse is left with a world of trouble, as described in the article “Protect Your Spouse and Children by Updating Your Estate Plan” from The National Law Review. Consider an update to your estate plan to protect your spouse and children.

The documents that need to be updated beginning with the will. In one example, a will from a prior marriage left all of a person’s assets to their prior spouse and siblings. Under New York and New Jersey state law, gifts to prior spouses are automatically revoked by law. What does that mean? All assets pass to the alternate beneficiary, who is named in the first will. For this particular spouse, that means that all the deceased spouse’s assets went to the siblings and not the new spouse.

In New Jersey and New York, spouses can elect against a will to claim a share of the deceased spouse’s assets, but this only applies to a third of their assets. That’s far short of what a spouse usually wants for their surviving spouse and children.

The only thing worse than an out-of-date will is no will at all. In another case, a spouse died without having a will. The law in New Jersey provides that in this situation, most assets will go to the surviving spouse, but almost a quarter will go to the deceased’s parents, if they are still living. If there are children from a prior marriage, then a little more than half of the estate will go to the surviving spouse.

The other bad part of having an out-of-date will almost always means that beneficiaries have not been updated. Here’s where things can get even worse.

Assets that have designated beneficiaries do not pass through probate and go directly to the beneficiaries. How bad this can be, depends upon what assets are owned with a designated beneficiary, and how long ago the beneficiaries were named. In some states, prior spouses are removed as beneficiaries by the operation of law, but that is not always the case. An estate planning attorney will be able to explain your state’s laws.

Here’s one more case where a failure to update estate plans caused real hardship for a family. A niece, and not the new spouse, was named as the beneficiary of the deceased’s IRA, which was a large asset. Several hundred thousand dollars went to the niece, instead of going to the man’s new wife and child. He simply never updated his beneficiary designation.

While 401(k)s are always left to the spouse under ERISA, unless spousal consent is given for another beneficiary to receive the 401(k), IRAs are given to whoever is named as a beneficiary. The same goes for life insurance policies, investment accounts, bank accounts and any asset with a named beneficiary.

Speak with your estate planning attorney now to be sure that your current will still reflects your estate planning goals. If you have remarried, welcomed a new child to the family, or had any other major life events, update your estate plan to ensure your spouse and children are protected. Don’t wait until it’s too late. If you are interested in learning more about updating your current estate plan, please visit our previous posts.

Reference: The National Law Review (March 16, 2020) “Protect Your Spouse and Children by Updating Your Estate Plan”

Category: 401(k)

How 401(K) Beneficiaries Work

What is an Eligible Designated Beneficiary?

Selecting a Beneficiary for My 401(k)

Using Retirement Funds in a Financial Crisis

What You Need to Know about Drafting Your Will

Utilizing the SECURE and CARES Acts?

Incorrect Beneficiary Designations are Trouble for Heirs

Coronavirus Stimulus allows Retirees to withdraw Money early

Update Your Plan to Protect Spouse and Children

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