1. Retirement Plan Beneficiaries Supersede Your Will
Most people assume that making a last will and testament will sort out all financial matters for their estate. And for the most part, a will takes care of distributing your assets to your beneficiaries. However, your retirement account is different, because you will designate a beneficiary for your company-sponsored retirement plans and IRAs.
You should know that the beneficiary designations for your retirement plans don’t typically pass through your will. Therefore, it’s important to review those beneficiaries to make sure they reflect your wishes. If you update your will, you should also update your beneficiaries for your retirement accounts, investment accounts, and life insurance policies accordingly.
2. Tax Consequences for Your Beneficiary
If your spouse is your beneficiary, they can take over your employer-sponsored retirement plan or IRA without additional tax consequences. They can receive distributions from the account over a lifetime. Unless you have Roth accounts, they will still pay income taxes on that income, but they won’t pay a penalty even if they haven’t reached the age of 59 1/2.
If your named beneficiary is not a spouse, they have to spend down the inherited retirement account within 10 years. It can be in one lump-sum, which may cause a large income tax obligation, or in separate withdrawals over 10 years. They can’t keep the IRA for their own retirement or roll it over into their personal retirement account.
There are other exceptions to this rule. For example, a minor child or disabled beneficiary or a beneficiary who is not more than 10 years younger than you can stretch the IRA to provide for them during their lifetime.
3. Do You Need a Trust or a Will?
For most people, a trust doesn’t provide enough benefits to warrant the additional cost compared to creating a will. Both can transfer your assets upon your death. However, with a will, you simply divide the assets to your beneficiaries. With a trust, you still have control over your assets, and you can even distribute money during your lifetime.
A trust provides more control. For example, you may use a trust to limit financial distributions to a young adult until they become more responsible. You can also use a trust to provide a regular income for a dependent with a disability instead of giving them a lump sum to manage. If you’re not worried about keeping control, a trust does not provide any advantages over a will.
4. The Difference between Per Stirpes & Per Capita?
In wills and trusts, estate distributions differentiate between per stirpes and per capita. When you create a will or a trust, you designate beneficiaries who will inherit your wealth. Per stirpes or per capita will be the designations that decide what happens if the beneficiary dies. Check with your employer-plan and IRA which designation they use.
If the beneficiary dies, under “per stirpes,” the distributions remain in effect. Anything the beneficiary would have received from your will now passes on to their descendants. With per capita distributions, the distributions to the beneficiary become void by their death. The assets will revert to the estate, and then they’re shared equally among the other beneficiaries.
5. Leaving Your Retirement Plan to a Charity
You always have the option to leave your retirement plan to a charity. With the changes to lifetime distributions for non-spouse beneficiaries since the Secure Act, it may be better to leave your beneficiaries with other investments they can keep for a lifetime. Otherwise, your beneficiary will have to withdraw the money within 10 years of your death and pay taxes on that income.
