Naming Beneficiaries on Retirement Plans

Every retirement plan you own has a spot for you to designate a beneficiary. It seems like a simple problem right? Just pick someone you trust and everything will be okay. Couples name their spouse, singles name their parents or their children, everyone can think of at least one person they’d want to leave their money to and simply put them. Some people neglect to put anyone. Either scenario can be dangerous for numerous reasons and here are a few things to consider.

Beneficiary Rules

The rules of naming a beneficiary are not as simple as they may seem. A prime example is that many pensions and employer sponsored retirement plans (401Ks, etc) require that you name your spouse unless your spouse waives that right in writing. If the plan doesn’t require it, the state might. Other accounts will not let your assets directly transfer to a minor and will require the funds be given to a trustee or guardian instead. Be sure to check those first because they will hold precedence.

Here’s where the fun begins. Selecting a beneficiary, once you get past the laws and rules of the program, comes down to the mechanics.

Selecting a Beneficiary for Employer Retirement Plans

Spouses: If your spouse is the beneficiary, he or she will inherit the assets without paying federal estate or income taxes. However, starting at age 70.5, the spouse will have to start taking the required minimum distributions as mandated by his or her life expectancy. Those required distributions are taxed as income, as they would if you were taking it.

Everyone Else: Any nonspousal beneficiary (that’s what they call everyone else) must cash it all out (bad) within one to five years or roll the funds over to an IRA in a trustee-to-trustee transfer (same thing that happens when you rollover a 401k into an IRA). The rollover option was added effective 2007 but many plans haven’t changed their rules to allow this option, it’s best to double check.

Selecting a Beneficiary for IRAs

IRAs differ slightly from employer sponsored retirement plans.

Spouses: Spousal beneficiaries can just designate themselves as the account owner. There are no additional taxes.

Everyone Else: Everyone else has to cash out over the next five years or take annual distributions determined by life expectancy of either the beneficiary or the decedent, whichever would’ve had the higher life expectancy.