What happens to your retirement accounts when you die?

Despite the rough economy, you’ll probably leave money in your retirement accounts when you die. Here is a brief overview of what will happen to those accounts. Also, to ensure that your loved ones take possession in ways that maximize value, here are some tips for you to follow today.

Probate & Taxes

The money passes directly to the beneficiaries you have named on the account. Even if your estate is subject to probate, the retirement funds are not—unless you have failed to name account beneficiaries or if they have predeceased you.

If your estate is subject to estate taxes (state or federal), the retirement account balances will be considered part of your taxable estate. (There are exemptions to estate tax, however—most commonly, the marital deduction. Money you leave to your spouse will not be subject to estate tax.)

Beneficiaries will pay income tax on account distributions in the same way that you would. That is, withdrawals from accounts funded with pretax money—traditional IRA, 401(k), 403(b)—will be subject to income tax. Withdrawals from those funded with after-tax money—Roth IRA—will not be subject to additional income tax.

Beneficiaries on Your Accounts

You name beneficiaries on official forms provided by the retirement plan custodian. The legal requirements, in short:

• For IRAs and employer profit-sharing plans, you are free to name anyone you choose.

• For a 401(k) or 403(b) (except for public sector and church organizations), you must name your spouse as sole beneficiary. If you choose otherwise, your spouse must sign the waiver portion of the beneficiary form.

• And, if you live in a community property state, your spouse has a right to half of the money—despite your beneficiary designations. Again, to ensure your wishes are carried out, your spouse should sign a waiver, relinquishing any interest in the funds. The waiver must be acceptable to the plan custodian.

Your spouse. Your spouse has more flexibility with the inheritance than do other beneficiaries. He or she can:

• Roll the account into a traditional IRA or qualified employer plan—and treat it as their own
• Postpone minimum distributions until age 70 ½, or
• Roll the account to a beneficiary IRA (described for non-spouse beneficiaries, below).

In your planner, you should suggest that your spouse seek advice—from an expert in retirement-plan succession—to select the best options when the time comes.

Others. You can name other family members, friends or organizations as beneficiaries on your accounts. When you die, the non-spouse beneficiary should establish a beneficiary IRA:

• Roll the money directly to an IRA titled in your name for their benefit—such as “[your name], IRA, deceased July 1, 2005, for the benefit of [beneficiary name].”

• Extend the minimum distribution schedule according to his or her age (assuming the beneficiary is younger than you). The withdrawals must begin, however, in the year following your death.

In your planner, leave clear instructions for beneficiaries to roll your account balance directly to a correctly titled account. Recommend that beneficiaries seek advice from an expert in retirement-plan succession. Otherwise, they may be required to withdraw the money immediately (paying the associated taxes) and lose the benefits of tax-deferred retirement savings.

A trust. Naming your living trust as beneficiary is not recommended:

• Retirement funds are already exempt from probate (as long as there is a valid beneficiary on the account).

• Beneficiaries may not be able to roll the funds to personal IRAs—even if they are the only beneficiaries of the living trust.

• Account withdrawals may be larger, because full distribution will be required within five years.

If you wish to use the money to fund a payment stream for beneficiaries, you could establish an irrevocable trust and name the trustee as the retirement-account beneficiary. To ensure your wishes are carried out, it is critical that you seek help from an experienced attorney. Irrevocable is irrevocable.

In general, the regulations guiding retirement-plan succession are complex. Any time you’ve questions about establishing your account, identifying beneficiaries or ensuring that your wishes will be carried out, you would be wise to seek expert counsel.

Finally, the account beneficiaries will receive the retirement money regardless of how your will or other estate planning documents read. For this and another reason, then, you should periodically review your account designations, updating them if necessary:

• When you’ve a significant life change—for example, if you become widowed, divorce or marry—ensure that your retirement beneficiaries reflect your current wishes.

• And, because account custodians can “lose” your beneficiary designations during a system conversion (whether related to a business merger or not), ensure that your designations remain correctly recorded.

Melanie Cullen is the author of Get It Together: Organize Your Records So Your Family Won’t Have To (Nolo), a workbook/CD-ROM for preparing and organizing your important records—for yourself and for your loved ones. She is a management consultant with TerraSys Consulting, Inc. and serves on the Projects@Work editorial board. She holds an MBA from the Graduate School of Business at Stanford University.





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