Pension and retirement accounts often form a large portion of an individual's wealth and should be accounted for in an estate plan. If a retirement account holder completes a proper beneficiary designation, their account assets will bypass probate. Account holders often designate a surviving spouse or children as beneficiary, but they could also name a trust or a charity.

The benefit and beneficiary rules applicable to different retirement accounts vary and should be discussed with an estate planning attorney, especially with the recent passage of the SECURE Act.

Defined Benefit Plans (DB), Defined Contribution Plans (DC), and Beneficiaries

The only estate planning tool applicable to retirement accounts is the beneficiary designation.  An individual must own retirement accounts, so they cannot be transferred into a revocable living trust like most other financial accounts or property during the participant's lifetime.  Further, they cannot be jointly owned. Thus, adequately designated beneficiaries are the only way to control how these accounts transfer at the time of the participant's death.

Participants in an Employee Retirement Income Security Act (ERISA) --covered plan can select anyone to be the plan's beneficiary when they die.^[1]

●        Most plans regulated by ERISA name a person's spouse to automatically receive the benefit if the account holder dies first.

●        If the account holder wishes to select a different beneficiary, their spouse must consent by signing a waiver. Otherwise, the spouse is entitled to 50 percent of the plan's benefits, even if somebody else is named the plan beneficiary.

●        An ERISA plan holder who divorces and remarries should update the beneficiary designation to their current spouse. Otherwise, the former spouse may be in line to inherit the plan benefits.

●        An account holder who does not have a spouse can name an alternate beneficiary. This may be a person such as a child, parent, or sibling, but it can also be a charity or a trust.

●        The named beneficiary of an ERISA retirement plan takes precedence over somebody designated in a will as the plan's beneficiary when there is a conflict between the two.

●        When an ERISA retirement plan does not designate a beneficiary, the benefit passes to the participant's probate estate and is distributed along with other probate assets according to the will (if the participant has created one) or according to state intestacy law (if the participant has not created one).

ERISA does not cover IRAs. An IRA account holder can name a beneficiary (or multiple beneficiaries) to receive the account assets. They can also name their probate estate as the beneficiary of the IRA, in which case the account proceeds will be distributed according to their will (if they have created one) or according to state intestacy law (if they have not created one). A trust or charity can be designated to receive IRA funds as well. An IRA with no beneficiary designation is distributed under the IRA's governing document.

Employees with a DB plan may be able to name a beneficiary, but this right is not guaranteed because the employer owns the plan and sets the terms. For a DB plan, a current spouse may be entitled to a qualified joint and survivor annuity (QJSA) death benefit paid out over their lifetime. The plan may provide the annuity payout percentage, which could be at least 50 percent but no more than 100 percent of the annuity paid to the participant. It may be possible, with spousal consent, for a participant to waive the QJSA and select a different payment option. QJSA rules may apply to nondefined benefit plans only through an election.^[2]

The SECURE Act and Inherited Retirement Accounts

The Setting Every Community Up for Retirement Enhancement (SECURE) Act, passed in 2019 and effective in 2020, affects DC plans like 401(k)s and IRAs and has implications for estate planning.

Under the SECURE Act, the age at which retirees must make annual withdrawals, called minimum required distributions (RMDs), increased from 70.5 to 72. In 2023, that age was raised to 73.

A retiree who lives long lives might deplete a large portion of their retirement account due to RMDs and have little left to give to heirs. However, the SECURE Act also affects those who inherit an IRA or 401(k) more directly.

While beneficiaries of these accounts always had to pay taxes on all withdrawals from them, before the SECURE Act, they could stretch out withdrawals over their life expectancy to minimize their tax bill. Beginning in 2020. However, most non-spouse retirement account beneficiaries must completely withdraw the balance of their inherited portion within 10 years of the original account holder's death.--- For minors, the 10-year rule starts when they turn 21. These new rules do not apply to a surviving spouse named as an account beneficiary. Spouses who inherit retirement accounts still receive preferential tax treatment in the SECURE Act. A popular option is for the inheriting spouse to roll over the account into their own IRA and name their beneficiaries for the account. The spouse is then treated as the original IRA owner for income tax purposes.^[3]

Another option for an account holder when designating a beneficiary is establishing the account owner's trust rather than naming individual beneficiaries. When the accounts transfer into the trust upon the account owner's death, the language in the trust agreement will direct how and when the retirement proceeds will be distributed to trust beneficiaries. The retirement account owner might prefer this option if they are concerned that the beneficiary might immediately deplete money or fail to set aside enough funds to cover taxes that might be due on withdrawals. Also, trusts can provide asset protection from creditors and help centralize asset management.

Retirement Accounts and Estate Planning

You saved hard for your retirement. The money you set aside could benefit more than just you. Most retirement accounts can be transferred to your heirs when you die, enabling them to supplement their savings goals.

Retirement assets can be transferred directly to properly designated beneficiaries outside of probate. However, these assets will be subject to federal and state income tax and possibly estate taxes. The SECURE Act could further impact your estate planning efforts.

Your retirement accounts could be the single largest store of economic value that you leave behind. To maximize their value to loved ones after you are gone, be sure that you understand the different inheritance and tax rules that may apply, review beneficiary designations regularly, and speak to an estate planning attorney about how to best provide for your family's future.

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If you have questions about retirement and estate planning, contact our office to speak to an estate planning attorney.

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