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Proper Estate Planning Requires Proper Retirement Planning

Written by Jordan W. Jacob, Esq.

January 21, 2019
Estate Planning and Retirement Planning - Ari sees retirement savings

You worked hard all these years to build up your individual retirement account (IRA), 401(k), or other retirement savings, so that you have money to fall back on during your retirement, and to help ensure your family is taken care of when you are gone. However, failing to properly add your retirement accounts to your estate plan has its consequences.

Some people assume if their will or trust documents name a specific heir as the beneficiary of their retirement accounts that there is no need to also list the same person as the primary beneficiary in their actual retirement account paperwork. Because of this, those people mistakenly leave their retirement account beneficiary form blank, or merely list “my estate” as the named beneficiary.

THIS IS A MAJOR MISTAKE — and one that can lead to serious complications and expense.

Traditional retirement accounts are not like other estate assets

First off, your traditional retirement accounts are treated differently than other assets, such as a car or house. The person you name on your retirement account beneficiary form is the one who will inherit the account’s funds, even if a different person is named in your will or in a trust. Your retirement account beneficiary designation controls who gets the funds, no matter what you may indicate elsewhere.

Given this, you must ensure each of your retirement account’s beneficiary designation forms are up to date and lists either the name of the person you want to inherit your account, or the name of the trustee of your trust, if you want it to go to a revocable living trust or special retirement savings trust you have prepared.

For example, if you listed an ex-spouse as the beneficiary of your retirement accounts and forget to change it to your current spouse, your ex will get the funds when you die, even if your current spouse is listed as the beneficiary in your will or trust.

Probate problems

Failing to name a beneficiary, or simply naming “my estate” in the retirement account’s beneficiary designation form means your retirement account will be subject to the court process called probate. Probate costs unnecessary time and money, and guarantees your family will get stuck in court.

When you name your heir on the retirement account beneficiary form, those funds will be available almost immediately to the named beneficiary following your death, and the money will be protected from creditors. But if your beneficiary has to go through probate to claim the funds, he or she might have to wait months, or even years, for probate to be finalized.

Moreover, in order to obtain your retirement account funds, your heir may also be on the hook for attorney and executor fees, as well as potential liabilities from creditor claims, that are unavoidably associated with probate, thereby reducing the retirement account’s total value.

Reduced growth and tax savings for IRAs

Another big problem caused by merely naming “my estate” on your IRA beneficiary designation, or forgetting to name anyone at all, is that your heir will lose out on an important opportunity for tax savings and growth of the funds. This is because the IRS calculates how the IRA funds will be dispersed and taxed based on the owner’s life expectancy. Since your estate is not a human, it is ineligible for a valuable tax-savings option known as the “stretch provision” that would be available had you named the appropriate beneficiary.

Typically, when an individual is named as the IRA’s beneficiary, he or she can choose to take only the required minimum distributions over the course of his or her life expectancy. “Stretching” out the payments in this way allows for much more tax-deferred growth of the IRA’s invested funds and minimizes the amount of income tax due when withdrawals are made.

However, if the IRA’s beneficiary designation lists “my estate” or is left blank, the option to stretch out payments is no longer available. In such cases, if you die before April 1st of the year you reach 70 ½ years old (the required beginning date for distributions), your estate will have to pay out all of the IRA’s funds within five years of your death. If you die after age 70 1/2, the estate will have to make distributions over your remaining life expectancy.

This means the beneficiary who eventually gets your IRA funds from your estate will have to take the funds sooner—and pay the deferred taxes upon distribution. Furthermore, this limits their opportunity for additional tax-deferred growth of the account and requires him or her to pay a potentially hefty income tax bill.

[AUTHOR NOTE: Since the publishing of this article, the Federal laws surrounding retirement accounts and distributions has changed; to wit – The SEURE Act.  Please refer to my article here to learn more.]

A simple fix

Fortunately, avoiding these mistakes is easy. Always remember to name your chosen heir as beneficiary in BOTH your retirement account paperwork AND your will or trust documents. It is equally important to name a few alternate, contingent beneficiaries in the event something happens to your primary beneficiary. Additionally, you must always remember to update your named beneficiaries if your life circumstances change, such as after a death or divorce.

With me as your Personal Family Lawyer®, I can help you select the ideal beneficiary for your retirement accounts and other estate assets. What’s more, I have systems in place that will ensure your designated beneficiary form is always up-to-date with the correct heir listed should your life circumstances dictate a change.

Schedule a no-cost initial consultation with me today to get started!

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