A tremendous amount of confusion and misinformation surrounds your beneficiary and leaving moo-lah to your heirs.
It’s time for: Dave’s Quick and Easy (and Important) Guide to Understanding Beneficiary Arrangements.
It is essential that your beneficiary arrangements match your desires, and today I am going to dispel some common misconceptions. Get ready to learn.
Retirement Accounts
On any sort of retirement account (IRA, 401k, Roth IRA, etc.), you are able to name primary and contingent beneficiaries.
Example:
IRA Account Holder: Joey Jenkins
Primary Beneficiary: 100% going to Joan Jenkins (wife)
Contingent Beneficiaries: 50% going to Johnny Jenkins (son)
50% going to Jackie Jenkins (daughter)
If Joey (husband) were to die, Joan (wife) would take possession of the retirement account assets and do a direct rollover the money to her own retirement account. There is no taxation on this kind of transaction.
If Joey and Joan were to die in an accident, then Johnny (son) and Jackie (daughter) would each receive half of Joey’s retirement account.
Johnny and Jackie then have two options:
Option #1– Take the money in cash. With this option, Johnny and Jackie would be required to pay taxes on their full share of the inheritance. So if Johnny (the son) were to receive his portion of $300,000, he would then be required to claim all of that money as income on his tax return for that year. He very well could pay $100,000 to Uncle Sam in federal income tax.
Option #2- Roll the money over into an Inherited IRA. This option would allow Joey to pay no taxes for now. As he pulls money out from the account over time, he would have to pay income taxes on whatever amount he withdraws.
An Inherited IRA is a great way to stretch out the tax liability, as the beneficiary has up to ten years to withdraw the money.
Also, remember that the 10% tax penalty does not apply to an Inherited IRA (you do not have to wait until 59 ½ to take money out of an Inherited IRA).
Important Notes
- You can change primary and contingent beneficiaries at any time.
- If you have a 401k, by law, your spouse mustbe the primary beneficiary (unless they sign a waiver). This is not the case with IRA’s.
- Beneficiary arrangements on retirement accounts supersede your will. This is essential to understand. If your will instructs your IRA to go to your son, and your IRA account names your daughter as beneficiary- the daughter gets the money. It doesn’t matter what the will says. The beneficiary designation trumps the will.
Non-Retirement Accounts
Now let’s move on to non-retirement assets. These would include cash, savings, brokerage accounts, stocks, bonds or anything else you possess outside of your 401k or IRA. Your home and other properties would also fall under this category.
These assets fall under completely different rules.
For these accounts, you are able to set up a Transfer Upon Death designation (commonly referred to as a TOD). So if Joey Jenkins has a savings account titled in his name, and his desire is for the account to transfer to his wife upon his death, the account would look like:
Owner: Joey Jenkins TOD Jackie Jenkins.
Important Notes
- A TOD designation avoids probate. The money transfers to the beneficiary immediately upon your death.
- You can name more than one person on your TOD instructions. You can split up the beneficiaries just like a retirement account.
- In Florida, you cannot place a TOD on your home or other real estate.
- Setting up a trust can also accomplish the same thing, but a TOD might be simpler.
- Annuities held outside of retirement accounts require you to name a beneficiary. Therefore annuities operate in a very similar fashion to retirement accounts.
- Life insurance also operates under beneficiary rules similar to retirement accounts.
Wow! That was some technical (and important) information.
This info can help you avoid probate and make sure the right people get the right money.
Throughout my career, I’ve seen outdated beneficiary instructions create messy situations. I’ve even seen spouses forget to take their ex-spouse off of their accounts! Don’t let your ex get your 401k!
Be Blessed,
Dave