What a Will CanNOT Do. Part III.

A Will cannot name the beneficiaries of your IRA.  Or your 401(k).  Or your SEP or Simple retirement plan.

THIS POST IS VERY IMPORTANT.  PLEASE READ.  If you only remember one thing from reading our blog, I hope it is this post.  Because it can save thousands in income taxes.

This post applies only to retirement funds such as IRAs, SIMPLE IRAs, SEP plans, 401(k)s, and all other investments which are tax deferred.  (This does not apply to Roth IRAs.)  As you know, when you contribute to one of these retirement plans, you are able to deduct your contribution from your total income on your income tax return for that year.  But you are not avoiding the income tax, you are simply deferring or delaying it.  Hopefully, to a time when you are in a lower tax bracket, or to be inherited by your spouse, your children, or others.

When you die, IF you have named a living, breathing person as your beneficiary, that beneficiary will have the option to again delay the income tax consequences by delaying the withdrawal of the money, usually over their lifetime.  (A spouse can simply rollover the deceased spouse’s account into their own account.)  However, IF you have never named a beneficiary, or you name your “estate” or “trust”, ALL of the money must be withdrawn within five years from your death.  And the income tax must be paid when the withdrawals are made.

Here’s an example (it’s overly-simplified, but you’ll get the picture):  You have a 401(k) worth $500,000.  You forget to name anyone as a beneficiary.  You die.  You have no spouse and one daughter.  Your daughter is a middle school teacher, and is in the 15% income tax bracket.  She will have to withdraw all of the money within five years and pay income tax on it based on your estate’s income tax bracket, which will be 39.6%—leaving only approximately $300,000 left for her.

IF you had seen us and been advised of this fact, you would have named your daughter as your beneficiary.  She would have been able to stretch out the distributions over her lifetime (not over five years), and she would have only had to pay income tax on what she withdrew and at her personal income tax rate (15% instead of 39.6%).  Then, whatever was left when she died could pass to your grandchildren, who could again stretch out the distributions (and tax) over their lifetimes and at their personal income tax brackets, because their mother would have named them as beneficiaries.

There are always exceptions in the law, and this is where we can really help.  If you want to avoid the income tax consequences, but you want or NEED a trust for your son or daughter because they are a spendthrift, have a substance abuse problem, or a greedy spouse, we can assist you by preparing what is called a “conduit” trust, which enables you to name a Trustee to control the distributions.  In this case, you do not have to name the children as beneficiaries.  You get to put the money in trust, but you also get the benefit of stretching out the distributions and paying taxes at the beneficiaries’ personal income tax rates.  But these are complicated, as are most documents that the IRS wants to pick apart.  Maybe you want your grandchildren to be your beneficiaries, but they are very young.  We can help with that as well.  There is a way to protect the retirement money and delay the income taxes.

TO RECAP, PUT THE NAME OF LIVING, BREATHING INDIVIDUALS AS BENEFICARIES ON YOUR RETIREMENT FUNDS.  See us if you want a Trust to protect the money.  But, it is not enough to put the names of your beneficiaries in your Will.  You HAVE to name them as beneficiaries on the account.

And in case you are thinking, “Well, I’ll name my husband and when he dies, I will add the kids as beneficiaries”, think again.   You could die together, and neither of you would have that chance to name the kids.  We recommend that you name the spouse as primary and the kids as secondary, or contingent, beneficiaries.

Ashley and I have handled estates where this has happened, and we have seen the devastating consequences.  An $850,000 asset suddenly becomes worth $535,000.

We take your estate planning seriously.  We don’t just slap together a Will for you and hope for the best.  We review your assets, how they are held, and who your beneficiaries are.  We will help you with correctly naming beneficiaries with your banks or brokers.  And we are less expensive than the IRS.

For more information, see Ashley’s post on  Estate Planning for Retirement Benefits.

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