Selecting Beneficiaries for Retirement Accounts

By: Stacey Nickens

When you think of estate planning, you may think of wills, trusts, and powers of attorney. However, these documents don’t determine who receives the assets held within your retirement accounts and insurance policies. To ensure those assets are passed to the correct people, you need to designate your chosen beneficiaries.

To begin with, you must designate a primary beneficiary for your retirement accounts and insurance policies. This beneficiary would receive those assets upon your passing. You can choose to split the designation between multiple people or qualifying trusts. If you are married, your spouse is the most tax-advantaged primary beneficiary that you can choose.

Should your primary beneficiary pass away before you, your assets would pass to your chosen contingent beneficiary or beneficiaries. There are instances where someone has not selected a contingent beneficiary or the contingent beneficiary has also passed. In those cases, the assets are transferred into your estate.

In most cases, assets are distributed per capita to each of your beneficiaries. What is a per capita designation? Pretend you have two children who each stand to inherit 50% of your IRA as your primary beneficiaries. However, one of your children passes before you do. According to a per capita designation, your remaining child/beneficiary would receive 100% of the assets within your IRA. A per capita designation is often the default designation for retirement accounts and insurance policies.

You could alternatively choose to have your assets distributed per stirpes. Let’s take the above example. If your deceased child had children of their own, your deceased child’s portion of the IRA would pass to their children, or your grandchildren, should you select a per stirpes designation. Your remaining, living child would only receive their 50% of the IRA’s assets. You typically must include the words “per stirpes” after a beneficiary’s name for this designation to be chosen.

As I mentioned above, it is often beneficial for a married person to select their spouse as their primary beneficiary. Doing so would allow your spouse to rollover your assets into their own retirement account. Your spouse would also gain immediate access to your assets and avoid probate. Unlike with other beneficiaries, your spouse can delay taking distributions until the time at which you would have turned 72, and your spouse can select new beneficiaries for those assets. However, because your assets would rollover into your spouse’s account, family’s with large estates may face state or federal estate taxes following this rollover process.

You can also select a non-spouse beneficiary, but doing so could have greater tax consequences. Most non-spouse beneficiaries are required to withdraw the entire amount of an inherited IRA within 10 years and would accordingly have to pay taxes on those withdrawals. Only Eligible Designated Beneficiaries can take withdrawals throughout their lifetime. Eligible Designated Beneficiaries include a surviving spouse, a minor child of the deceased, someone who is disabled or chronically ill, or someone who is within 10 years of age of the deceased.

Rules for Roth IRAs are slightly different. Withdrawals from an inherited Roth IRA funded at least five years prior to the original owner’s death are not taxed or subjected to early withdrawal penalties. You still must withdraw the Roth IRA funds within 10 years.

Beyond selecting an individual or individuals as your beneficiaries, you can also leave your assets to a trust, estate, or charity. Leaving your assets to a trust requires you to name a trustee to manage those assets. This option could make the most sense for families with large estates, families with complex bequests, and families with members who cannot manage their own finances. Finally, leaving your assets to a charity could have some tax benefits. The assets would be included in the gross value of your estate, but your estate would receive a tax deduction for the contribution.

It is beneficial to annually review your beneficiary designations on your retirement accounts and insurance policies. When doing so, check that you have designated the correct beneficiaries and that the beneficiaries’ information is correct. Improper beneficiary designations can lead to probate and/or tax consequences, and a regular review of your beneficiary designations can help you avoid those issues.