After you open a retirement account or purchase a life insurance plan, you must take the final step of designating beneficiaries. Some retirement account providers, in particular, let you open an account and begin contributing money without a beneficiary designation. There are a few reasons why you need to follow up and pick a beneficiary, and a few considerations when picking one.
First, if your account has no beneficiary named if the primary beneficiary is deceased and there is no successor beneficiary, or if both the primary and successor beneficiaries are deceased, the account value goes to your estate after your death. This could dramatically increase the value of your estate and require payment of substantial estate taxes. It also would increase the cost of probate in California.
Second, the law requires accelerated distributions from some accounts, such as IRAs, when there is no beneficiary. Usually, beneficiaries get to decide how much of a distribution to take from the account each year. If they choose the required minimum distribution (RMD), they will have the lowest taxes and continue to earn interest on the money in the account. If there is no beneficiary, the IRS requires that all money be distributed out of the account within 5 years. This leads to increased income taxes for heirs of your estate and less benefit from interest accumulation.
In short, you need to name a beneficiary for all your retirement accounts and life insurance, and you need to do it as soon as possible. Talk to your administrator or account provider – usually, you fill out a simple form. Generally, you do not want to designate your estate as the beneficiary. Choose an individual, living person, and select a backup beneficiary too. In the alternative, your lawyer may suggest that you choose an entity like a trust or charity, but there may be tax implications to doing so.
When choosing beneficiaries, think about what will happen if and when they receive payments from the account. For example, a parent leaving a 401(k) to a child with special needs should consider setting up other estate planning structures to hold the 401(k) money instead of giving it directly to the child. Otherwise, the child may not qualify for income-based state and federal programs. This is a complicated area of estate planning that should be explored with the help of an attorney.
People with non-U.S. citizen, non-resident spouses should be aware that the IRS requires a 30% withholding rate on distributions from retirement accounts to non-citizen non-residents. This means that your spouse would receive substantially less in distributions than you might expect. Alternatively, you can speak to an estate planning lawyer about setting up a trust or other estate planning structure to act as beneficiary, and from which your spouse can receive a benefit.
If you need guidance in making beneficiary designations or other future planning, look to Janet Brewer, Esq. for thorough and thoughtful estate planning advice. Janet’s more than 20 years of legal experience will give you confidence and peace of mind. To schedule a “Get Acquainted” meeting, visit Janet's website or call her office at (650) 469-8206.