Any well-crafted estate plan must include planning for 401ks and IRAs, and with good reason: in 2017, the U.S. Census Bureau estimated that nearly one-third of family wealth is held in retirement accounts. Understanding how those assets are transferred after your death is a vital part of planning for your family’s future.
First, it’s important to realize that your will or revocable trust may not control how those assets are transferred. Most retirement accounts are considered non-probate assets, meaning the account owner will be asked to name the beneficiary who receives these after your death. Your will or estate plan has no bearing on how these assets pass, so it’s crucial that you discuss your assets with your attorney to make sure all pieces of your estate work together to accomplish your goals. It’s very common for owners to name these beneficiary designations when the account is established but forget to update these as circumstances change. If you haven’t looked at these in a while – and it’s even more critical if you’ve been married, divorced, or had children in the intervening years – it’s a good idea to contact your account custodian to revisit the designations today.
Second, beneficiaries should be aware of the tax consequences of inheriting pre-tax accounts. Generally, for tax-deferred accounts like traditional IRAs or 401ks, beneficiaries will need to report income in the year the accounts are paid out. The SECURE Act altered many of the rules around how quickly the balance of the account must be paid to any given beneficiary. An experienced estate planning attorney can walk you through this complicated set of rules and identify opportunities to minimize taxes to your heirs.
Lastly, account owners should realize that simply updating the named beneficiaries on the account is not the end of the story. Certain workplace-sponsored plans are governed by ERISA, which requires that a surviving spouse be named as a beneficiary. In community property states, like in my home state of Texas, spouses have a community property claim even when the account is titled only in one spouse’s name. Naming someone other than your spouse can trigger litigation and fighting among your heirs. Further, naming minor or disabled children may present challenges if the beneficiary is not legally permitted to own property or qualifies for government assistance. The wisest course of action is to work with your estate planning attorney and financial advisor to develop a comprehensive estate plan that makes a plan for all of your assets.