Retirement assets, including 401(k)s, IRAs, etc., comprise a large portion of the average American’s wealth. Planning for these assets is critical, not just due to their value, but also due to their special nature.
Retirement plan assets may be tax-deferred (like a traditional IRA or 401(k)) or tax-free (like a Roth IRA or Roth 401(k)). But, there may be very good reasons to have one or the other. I’ll examine these issues more closely in my next blog.
Whether the plan is an IRA or a 401(k), whether it is a traditional or Roth plan, they all share one important distinction: they are all controlled by beneficiary designations. These are not the only items in an estate plan which are controlled in this manner, but they are likely the most valuable. Other items controlled by beneficiary designation are life insurance, and may also include brokerage and bank accounts, as well as real estate in some states.
Assets controlled by beneficiary designation bypass the rest of the estate. It makes no difference to whom assets are left in the will or trust. The beneficiary designation controls. For example, let’s say a will leaves everything to your son. However, you have an IRA for which you complete a beneficiary designation in favor of your daughter. Your daughter will receive the IRA, not your son—even though he is left everything under your will. Perhaps you had a falling out with your daughter long after you completed the beneficiary designation. You decided to disinherit her and prepare a will leaving everything to your son. However, your son will not get the IRA, your daughter will, notwithstanding the new will. People often overlook this fact and make serious errors. They think if they have a new will prepared, the people receiving under the will would receive all their asserts. However, as the example above illustrated, this is not necessarily the case if there are beneficiary designated assets, like retirement assets.
It’s extremely important for a client to be forthcoming with their estate planning attorney about all their assets and beneficiary designations. It’s best for the attorney to request a copy of the beneficiary designation. Clients may have forgotten whom they designated as beneficiary of the asset.
Another reason beneficiary designations are critical on retirement assets like IRAs is that it sets the speed of withdrawals after your death. Typically, the assets must be withdrawn over the life expectancy of the oldest beneficiary. So, if you name your 60-year-old sister as the beneficiary, the funds must be withdrawn based on her life expectancy as of your death. If instead you name your son who is 20 years old, the assets could be withdrawn over his much longer life expectancy, in other words much more slowly. Of course, whomever you designate, they could choose to withdraw the assets more rapidly. But, there are advantages to being able to withdraw them more slowly and enable them to grow tax-free or tax-deferred over a longer period of time.
Beneficiary designations are extremely important in determining who receives assets, but also how quickly they must be withdrawn. In the next blog, I’ll examine some key differences between IRAs and 401(k)s and between Roth and traditional plans.
Stephen C. Hartnett, J.D., LL.M.
Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
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