If you have a qualified retirement plan or Individual Retirement Account (“IRA”), be sure to verify two things:
- Have you designated the primary and contingent beneficiary or beneficiaries who will receive any remaining accumulation that you don’t withdraw during your lifetime?
- Does that beneficiary designation meet requirements established by your plan administrator or custodian and the IRS?
Many working individuals accumulate substantial assets in their retirement plans, like a 401(k) plan or an Individual Retirement Account, where investments accumulate tax-free until withdrawn. If retirement accumulations are not exhausted during the employee’s lifetime, the employee may designate the beneficiary or beneficiaries who receive what remains. If a beneficiary has not been designated, the retirement plan or IRA will have default distribution provisions established by contract and consistent with IRS requirements. Those default provisions vary, but they may require the remaining accumulation be paid in one lump sum to the employee’s estate, over the deceased employee’s lifetime or within five years of the employee’s death. Every dollar so distributed is ordinary income to the recipient(s) unless the recipient is a tax-exempt charity. Income recognition by individual beneficiaries may be deferred to the extent the employee has designated a beneficiary who can withdraw any remaining accumulation over the beneficiary’s lifetime; in the meantime, undistributed amounts accumulate tax-free. Deferral of income recognition works best when a spouse is the designated beneficiary, and, if there is no surviving spouse, when separate shares are clearly created for named individuals.
But what if a married employee has children from a prior marriage and desires to leave assets in trust for a second spouse with remainder to those children? Or, what if the employee has children who are minors or may need protection? In such cases, a trust may be the appropriate designated beneficiary. When a trust is designated as beneficiary, the employee should consult with an experienced tax professional about how to designate the trust, and, in addition, confirm that the plan administrator or IRA custodian will accept the beneficiary designation as drafted. Generally, if the trust in question has multiple beneficiaries, the trust must be divided into separate shares for the beneficiaries, and the life expectancy of the oldest trust beneficiary will be used to determine how much must be distributed annually to all beneficiaries.
Retirement assets also are a tax-efficient source to fulfill an employee’s charitable intentions. But care must be taken in administering the beneficiary designation if both charity and individuals will share the retirement accumulation.