How Should You Handle Retirement Accounts in Your Estate Plan?

Retirement accounts tend to make up a significant portion of people’s wealth.

As you plan your estate, you must consider the impact your tax-deferred retirement accounts will have on your estate overall. These plans could include IRAs, 401(k)s and 403(b)s, among others. You should always take all the necessary steps to minimize the potential tax burdens your beneficiaries face.

In most cases, receiving an inheritance does not require you to pay income taxes. However, tax-deferred retirement accounts are a different story, as they are classified as income on which the government has not already collected taxes.

Let’s look at the traditional IRA as an example. Money in an IRA cannot be kept there forever—it must be distributed on a regular basis in accordance with federal law. The annual amount that must be distributed is called the required minimum distribution (RMD), and if the distributions do not meet or exceed the RMD, beneficiaries could have to pay a 50 percent excise tax on the total amount not distributed.

Dos and don’ts for retirement accounts in estate plans

Upon your death, beneficiaries to your retirement accounts will have to pay income tax on the amount of money withdrawn from your retirement account. Your beneficiaries must take their distributions from the accounts based on the life expectancy tables set by the IRS. Those distributions are then considered ordinary income. If more than one beneficiary exists, the person who has the shortest life expectancy will be the designated beneficiary for the purposes of distribution.

Therefore, as a part of your estate plan, you should include a means for beneficiaries to put off paying this income tax for as long as they can by delaying withdrawals from retirement accounts.

The best situation, from a tax perspective, is when you can name your spouse the beneficiary of the retirement account. Your spouse can roll over the account into his or her own and defer withdrawals until the age of 70 ½. Other beneficiaries would be forced to begin withdrawing money the year after your passing.

You should avoid making revocable trusts the beneficiaries of a retirement account, as it can limit the potential for beneficiaries to put off paying income taxes. The only situations in which you might consider naming a trust the beneficiary is if the life expectancy or spousal rollover options are unavailable. Even then, you should discuss your options with an estate planning attorney.

Ultimately, retirement accounts could add some complications to your estate planning, and you must be able to work out these complications in a way that minimizes the financial impact your beneficiaries experience. For more details on the strategies you may use to accomplish this, work with a skilled New York estate planning lawyer at Lissner & Lissner LLP.

Micheal Lissner
About the Author: Michael Lissner
Micheal D. Lissner is an experienced trust and estate planning and administration attorney serving the New York City area. He handles cases ranging from estate planning to trust administration, medicaid planning, elder law, and representation of survivors of the Holocaust and their heirs