What Happens to My Retirement Account When I Die?
Retirement accounts are integral to financial planning, as they offer a reliable source of income in the twilight years. However, it's crucial to understand what happens to these accounts upon the account holder's death so you can make sure your loved ones are adequately prepared and benefits are properly passed on.
Upon your death, retirement accounts are generally transferred to the beneficiaries you have designated within the account. The exact process and implications depend on the type of retirement account and how it is structured.
However, failure to designate a beneficiary can lead to the account being included in your estate, possibly subjecting it to probate and accompanying taxes. It is essential to have a clear and updated beneficiary designation to ensure a smooth transition of your retirement assets to your loved ones.
An estate planning attorney can help you with the specifics and secure the financial future of your heirs.
Types of Retirement Accounts
Individual Retirement Accounts (IRAs)
IRAs are a popular choice due to their tax advantages and flexibility regarding investment options. There are primarily two types: Traditional IRAs and Roth IRAs.
Traditional IRA: Contributions are typically tax-deductible, and taxes are paid upon withdrawal. Upon the account holder's death, named beneficiaries can either withdraw the entire balance immediately or choose to stretch distributions and taxes over time.
Roth IRA: Contributions are made with after-tax dollars, allowing for tax-free withdrawals in retirement. Beneficiaries of a Roth IRA can similarly either take a lump sum distribution or stretch the withdrawals. Note: Roth IRAs are not subject to required minimum distributions (RMDs) during the original owner’s lifetime.
401(k) Plans
Employer-sponsored 401(k) plans have different rules compared to IRAs. The account holder’s beneficiaries often have multiple options upon the account holder's death, although plans vary by the employer. From a general perspective:
Spousal beneficiary: If the spouse is the designated beneficiary, they may roll the 401(k) balance into their own IRA or keep the inherited funds in a beneficiary-designed IRA.
Non-Spousal beneficiary: Non-spousal beneficiaries can often take a lump-sum distribution, open an inherited IRA with distributions based on their life expectancy, or distribute the account over five years.
Required Minimum Distributions (RMDs)
RMDs come into play upon retirement and must begin at age 72 (73 if you reach age 72 after December 2022) for both Traditional IRAs and 401(k) plans. In the case of the account holder's death, beneficiaries must adhere to RMD rules related to inherited accounts. Note: Even though Roth IRAs do not have RMDs for the original owner, beneficiaries must take distributions.
Understanding Beneficiary Designations
Beneficiary designations are crucial in determining how retirement accounts are managed posthumously. Financial institutions typically require customers to name primary and contingent beneficiaries.
Primary beneficiary: The first in line to inherit the retirement account balance.
Contingent/Secondary beneficiary: Inherits the account if the primary beneficiary dies.
These designations override any directions provided in a will, making it paramount to keep these updated, especially after major life events such as marriage, divorce, or the birth of a child.
Process for Beneficiaries
Upon the retirement account holder's death, here are the general steps beneficiaries should take:
Notify the financial institution: The beneficiaries should inform the financial institution managing the retirement account of the account holder's death. This requires a death certificate.
Account transfer options: Depending on the beneficiary designation, beneficiaries will have various options, such as rolling over the funds into their own retirement accounts, maintaining the funds in inherited accounts, or taking distributions.
Tax implications: Beneficiaries must understand the tax consequences of their choices. Fast distributions could lead to a significant tax burden, whereas spreading distributions over several years may alleviate immediate tax impacts.
Consulting an Estate Law Attorney
The details involved in retirement account inheritance can feel daunting. Beneficiaries might confront various hurdles, from understanding RMD rules to managing tax implications.
Therefore, consulting an experienced estate administration attorney like Rodney Gould can provide invaluable guidance. Rodney Gould, based in Los Angeles, California, has estate administration experience and can help oversee the transition of retirement account assets, working to comply with legal requirements and the deceased's wishes.
Rodney Gould can assist with aspects such as:
Verifying beneficiary designations are up-to-date and correctly executed
Advising on the various rollover and distribution options to minimize tax liabilities
Handling the probate process if required
Joint Accounts and Spousal Rights
For married individuals, joint retirement accounts or accounts with spousal beneficiaries offer added protection and flexible options for the surviving spouse. Generally, spouses have more favorable conditions than non-spousal beneficiaries, such as options for spousal rollovers.
Rolling Over a Spouse’s IRA
A surviving spouse can roll the deceased's IRA into their own IRA, thus extending the tax-deferral benefits. This action is simple yet can have significant long-term financial benefits. The RMDs will be calculated based on the surviving spouse’s age, potentially lowering the annual required withdrawals.
Inherited IRAs for Spouses
Alternatively, the surviving spouse may treat the account as an inherited IRA. This option can be advantageous if the deceased spouse was younger because it allows the surviving spouse to delay RMDs until the deceased would have turned 72.
Trusts as Beneficiaries
In some cases, account holders may name a trust as the beneficiary of their retirement accounts. This can afford greater control over the distribution of assets, though it also adds complexity. Trusts can be used to:
Protect minors or individuals with special needs
Manage distributions if beneficiaries lack financial discipline
Provide for multiple generations
However, trust-based beneficiaries need careful planning to avoid undesirable tax consequences.
Seek the Answers You Need
If you are facing the potential inheritance of a retirement account and need advice on how to manage it, Rodney Gould can help craft a plan that meets both legal and financial needs. Contact the Law Office of Rodney Gould in Los Angeles for a personalized consultation.
Rodney Gould also proudly serves clients in Sherman Oaks, Studio City, West Hollywood, and Beverly Hills.