Passing your retirement assets to the right person

Passing your retirement assets to the right person

• The beneficiary designation for your retirement account—not your Will or trust—controls where that account goes.
• Take time to complete or review your retirement beneficiary designations to indicate who will receive your assets after you pass away.

[Note: This WealthFocus deals primarily with beneficiary designations for retirement accounts. For a discussion of life insurance beneficiary designations, see our WealthFocus on Understanding Life Insurance].

What is a beneficiary designation?¹

Your beneficiary designations control who gets your IRA and retirement plan assets when you pass away. Naming someone in your Will or Trust as the beneficiary of those assets generally does not change the beneficiary that you have designated in your IRA or plan documents. The custodian of your retirement assets will rely on the beneficiary designation in its files regardless of what your Will or Trust says.

The beneficiaries you name in your designation should be aligned with your wealth transfer goals. Many people choose a spouse as the beneficiary of their retirement assets because spouses often have more options than other beneficiaries. And, in fact, for retirement plans, your spouse must give consent if you name someone else as your beneficiary.  Note: some states and custodians require spousal consent for IRAs as well.

You also have the option to name one or more qualified charities as the beneficiaries of your retirement account, which avoids both income and estate taxes on the assets in that account.

What are my beneficiary’s rules for withdrawal?²

Once an account owner passes away, beneficiaries other than your spouse generally are required to open a beneficiary or inherited IRA and move the assets from your IRA or retirement account to that inherited IRA. The beneficiary then takes required withdrawals from that account. Those withdrawals are usually subject to income tax when they are taken.

Most beneficiaries are required to withdraw assets from the inherited account by the end of the 10^th year after the account owner’s death, with certain exceptions. Some of those exceptions are as follows:

• Spouses who are beneficiaries are one of those exceptions: spouses are generally able to roll the account into their own account as if they were the original owner, or designate themselves as the owner of the original account.  For the most part, the regular rules surrounding when account owners are required to take distributions would apply to amounts rolled over into the spouse’s IRA.  This may allow the spouse to stretch out withdrawals for as long as possible and get the most asset protection, assuming this option is in line with their other goals.  In some circumstances, though, it can make sense for a spouse to open an inherited IRA instead of putting the IRA into their name.
  • Sometimes, even if the spouse does not treat the IRA as their own, if the account owner dies before they would have been required to begin taking withdrawals, the spouse may be able to delay beginning to take withdrawals until the original account owner’s required withdrawals would have begun.
  • Planning tip: If you would like to name a trust for the benefit of a spouse, like a Marital Trust, as the beneficiary, consult your tax and legal advisors to ensure that the trust qualifies for the stretch benefit; if it doesn’t, it may be required to withdraw within 10 years after the account owner’s death, if not sooner.

• Other beneficiaries excepted from the 10-year rule are beneficiaries who are minor children, who are chronically ill, who have disabilities, or who are not more than 10 years younger than the account owner. Generally, these beneficiaries can stretch withdrawals over their life expectancy, although for minors the 10-year rule applies once they reach the age of majority.
  • Planning tip: Some trusts for the benefit of any of these beneficiaries may also be able to qualify for this exception to the 10-year rule; it is important to consult tax and legal counsel if you’d like to designate trusts as beneficiaries of your retirement accounts.
• Most other beneficiaries will generally take withdrawals within 10 years after the account owner’s death.
  • Planning tip: Estates, entities and certain trusts that do not qualify as so-called “see-through” trusts may be required to withdraw even sooner than 10 years after the account owner’s death.

Naming a trust to protect your beneficiaries

Inherited IRA and retirement plan assets may not be protected from the bankruptcy creditors of the beneficiaries.³  In light of that, you may wish to protect your assets by leaving them in trust rather than outright to your beneficiaries, even if it means that the trusts will have to withdraw the accounts sooner than the individual trust beneficiaries would have.  While you probably don’t expect your heirs to go bankrupt, a trust may be able to provide asset protection for other situations, such as a divorce.  However, leaving retirement assets in a trust can have its own particular complications, which should be clarified with your counsel.

Practical pitfalls when naming trusts as beneficiaries

• If you expect to have a trust in place for a long time (such as your children’s lifetimes), think about who will act as trustee. Most of the people you know and trust will no longer be available by the time the trust terminates, and an institutional trustee will often have annual costs for acting as trustee (even if it is not acting as the investment manager). The smaller the retirement account, the potentially higher the costs relative to the account’s value.
• Once you name a trust as the beneficiary of your retirement assets, it may be difficult to terminate the trust and distribute the IRA to the trust’s beneficiaries while maintaining the tax benefits of the IRA. If circumstances change, the trustee may decide that a trust is no longer necessary or desirable. However, without express authorization, transferring the retirement account to the trust’s beneficiaries can be difficult.

The rules that apply to the timing of required withdrawals from inherited retirement accounts are complex, and there is some uncertainty as to how some of the rules apply. Talk to a J.P. Morgan representative and your legal and tax counsel to make sure your existing beneficiary designations reflect your wishes and are coordinated with the rest of your planning.