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NAMING RETIREMENT PLAN BENEFICIARIES
 
Choosing the right beneficiary of your retirement plan can have a major impact on the minimum distribution period after your death—and possibly affect minimum distributions during your life, as well.

Q: I have about $150,000 saved up in my retirement plan, and I am unsure whom to name as the beneficiary. Should I name my husband, my children, or my estate?

A:: To determine the “best” alternative for choosing beneficiaries of your retirement plan, it is important to keep in mind that one of the goals of retirement fund planning, whether you are dealing with an IRA, Keogh, 403(b) plan, or other type of plan, is to delay required distributions for as long as possible (you, or your beneficiary, can always withdraw more than the required minimum, if desired). To avoid any penalties, distributions must in all cases begin by April 1 after the calendar year in which you turn age 70½ (this is called the “Required Beginning Date” or “RBD”).

Delaying distributions achieves important purposes: (1) no taxes are payable on the retirement fund assets until they are withdrawn or distributed, (2) no income tax is payable on the income and capital gains earned by the fund while the assets remain inside the plan, and (3) a distribution will usually be taxed at a lower rate if it is made in smaller amounts or when you or the beneficiary is in a lower tax bracket.

Naming Your Estate

With this in mind, naming your estate as the beneficiary of your plan is probably the worst thing you can do. If you name your estate (which is treated as if you have named no beneficiary), and die before your RBD, all of the money in the plan will have to be paid out to the beneficiaries of your estate by December 31 of the fifth year after you die. In such case, you will have unnecessarily accelerated the payment of income tax on the plan balance

Naming Your Spouse

On the other hand, if you name your spouse, he will have several options following your death, all of which result in greater deferral:
  • He can leave the plan assets as is and defer taking distributions from the plan until the later of (i) December 31 of the year after the year of your death, and (ii) December 31 of the year you would have turned age 70½ (which is particularly beneficial if you are younger than your husband).
  • He can rollover the plan assets into his own IRA and then wait until December 31 in the year after he turns age 70½ to begin taking distributions, which is helpful if your husband is more than a year or two younger than you.
  • If your husband is named as your beneficiary, and he is more than 10 years younger than you are, you can get a greater deferral during your life than if you named your children as beneficiaries.
  • Note that following your death, if no IRA rollover was made, payments must be made over your husband’s life expectancy, alone, during his life. If a rollover was made, payments can be made over a longer period of time based on the official tables. This is based on the joint life expectancy of your husband and a hypothetical person 10 years younger than he is, recalculated each year. Again, this allows for additional deferral of taxes.
  • If he rolls over the amount in your plan into his own IRA, he can also name additional beneficiaries for the period after his death, such as your children. Then, following his death, the children can achieve tax deferral over their own life expectancies.
  • Finally, if your total taxable estate exceeds approximately $2,000,000, another factor is that naming your husband as the beneficiary of your plan may reduce the amount of estate tax payable on your death (but possibly increase estate taxes at his death; see my article Naming a Revocable Trust as Beneficiary of a Qualified Retirement Plan).
Naming Your Children

After your death, the child named as beneficiary will be able to withdraw the plan assets over the life expectancy of the child, as of your date of death. If you name all of your children, it may be important that separate accounts be established for each child. If there is a separate account for each child, then each child can withdraw over that child’s own life expectancy. If there is only one account for all children, then distributions must be made over the life expectancy of the oldest child. It may also be possible to create separate accounts after your death.

Naming a Trust

Naming a trust can be tricky, and is further discussed in my article Naming a Revocable Trust as Beneficiary of a Qualified Retirement Plan. Suffice it to say that it can be done, and indeed ought to be done if you are married, your major asset is your retirement plan, and you have a taxable estate (over $2,000,000, including your retirement plans). If you are single and wish to manage and protect your retirement plan assets for the benefit of your children or other young beneficiaries, a trust may also be a wise choice. Call us to assist you with these decisions, to set up the correct type of trust, and to coordinate the beneficiary designations.

Dying After the RBD

Once you reach your RBD, the plan will have to make distributions to you in order to avoid a 50% penalty tax on amounts that should have been distributed to you but weren’t. If you die after this date and you have not named a proper beneficiary, the payments must continue to be paid out at least as rapidly as they were being paid out at the time of your death.

Deferral of distributions from the plan can be achieved by naming a beneficiary. For example, if you are age 75 at your death, and you had no beneficiary other than your estate, the distributions must be made ratably over a 22.9-year period. On the other hand, if you had named your 40-year-old child as your beneficiary, your child can take out payments over his or her own life expectancy at that time (43.6 years). Again, the longer you can stretch out the payments, the better; remember, you (or your child) can always withdraw more than the minimum, if needed.

Plan Variations

All of the above rules assume that your plan permits the maximum flexibility allowed under the IRS rules. Unfortunately, many plans do not give you all of these options. There is no way to know without scrutinizing the actual plan document that applies to your own particular situation. I’m sorry, but either you or your advisor will have to put on those tri-focals and read the fine print.
 
 
Boulder ElderLaw
Law Office of K. Gabriel Heiser

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Boulder, CO 80301
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