An important and often overlooked element of employer sponsored retirement plans and individual retirement accounts is the designation of a beneficiary. In the absence of a designated beneficiary, the proceeds from your retirement account would revert to your estate, which means the proceeds would have to pass through probate instead of transferring directly to your intended recipient. Additionally, your beneficiary could be subject to adverse income taxes. By naming a beneficiary, the proceeds pass directly to the beneficiary upon your passing and the beneficiary has more control over the distributions taken from the assets and the ultimate tax impact of the additional income.
Did you know there are different designations for beneficiaries?
A designated beneficiary is whomever you identify on your beneficiary designation form. You actually don’t have to specify this person by name. Technically you could name “my wife” or “my children” as beneficiaries, but it’s always advisable to be as specific as possible to ensure your wishes are fulfilled.
Under current law, a designated beneficiary is required to withdraw all assets from a retirement account by December 31st of the 10th anniversary of the decedent’s death. There are no annual minimum requirements. The sole requirement is for all assets to be withdrawn by December 31st of the 10th anniversary of the decedent’s death.
Certain designated beneficiaries are classified as “eligible designated beneficiaries” and have more flexible account withdrawal requirements. The following are considered eligible designated beneficiaries:
- Surviving spouse
- Minor child of the decedent
- Disabled individual
- Chronically ill individual
- Individual not more than 10 years younger than the decedent
Surviving Spouse has the most options
The surviving spouse has the most withdrawal options. He/she has the option to withdraw all the funds and pay the taxes for the funds withdrawn. Alternatively, the surviving spouse could execute a spousal rollover into an IRA in her/his name. The spouse can then treat the IRA as if it was his/her own and defer any distribution of assets until she/he attains age 72. At that time, the surviving spouse would be subject to required minimum distributions according to the IRS Uniform Lifetime Table. Importantly, if the surviving spouse is less than 59 ½ years old and needs funds from the deceased spouse’s retirement account, this option would not be the right one as the spouse would be required to pay the 10% early withdrawal penalty in this scenario.
Another alternative for the surviving spouse is to create an inherited IRA. The distributions from the inherited IRA are based on the beneficiary’s life expectancy. The beneficiary must begin taking distributions from the plan by December 31 of the year following the decedent’s year of death. Under this scenario, the surviving spouse would have access to funds irrespective of his/her age.
Non-spouse Eligible Designated Beneficiaries
Non-spouse eligible designated beneficiaries have fewer options than a surviving spouse. These eligible designated beneficiaries can elect to take distributions over her/his life expectancy or may take distributions within 10 years of the decedent’s death.I know there’s a lot of information here. The main takeaway is that you need to designate a beneficiary on all retirement plans and retirement accounts. If you have questions about specific details or how to approach the process strategically, I would be happy to discuss this with you.