Setting up and participating in a retirement plan are important parts of an architect’s financial future. When you have a retirement plan, it is important to name a beneficiary. Understanding the options involved in setting a retirement plan beneficiary is an important part of your decision-making.
Selecting beneficiaries for retirement benefits is different from choosing beneficiaries for other assets such as life insurance. With retirement benefits, it’s important for you to know the impact of income tax and estate tax laws in order to select the appropriate beneficiaries. Although taxes shouldn’t be the sole determining factor in naming your beneficiaries, ignoring the impact of taxes could lead you to make a less optimal choice.
In addition, if you’re married, beneficiary designations may affect the size of minimum required distributions to you from your IRAs and retirement plans while you’re alive.
Income Tax on Retirement Distributions
Most inherited assets such as bank accounts, stocks, and real estate pass to your beneficiaries without income tax being due. However, that’s not usually the case with 401(k) plans and IRAs.
Beneficiaries pay ordinary income tax on distributions from Traditional 401(k) plans and traditional IRAs. With Roth IRAs and Roth 401(k)s, however, your beneficiaries can receive the benefits free from income tax if all of the tax requirements are met. This means you need to consider the impact of income taxes when designating beneficiaries for your 401(k) and IRA assets.
For example, if one of your children inherits $100,000 cash from you and another child receives your Traditional 401(k) account worth $100,000, they aren’t receiving the same amount. The reason is that all distributions from the Traditional 401(k) plan will be subject to income tax at ordinary income tax rates, while the cash isn’t subject to income tax when it passes to your child upon your death.
Similarly, if one of your children inherits your taxable traditional IRA and another child receives your income-tax-free Roth IRA, the bottom line will be different for each of them.
Naming or Changing Beneficiaries
When you establish an IRA or 401(k), you complete a form to name your beneficiaries. Changes are made in the same way–you complete a new beneficiary designation form. A will or trust does not override your beneficiary designation form. However, spouses may have special rights under federal or state law.
It’s important to review your beneficiary designation form at least every two to three years. Also, be sure to update your form to reflect changes in financial circumstances. Beneficiary designations are important estate planning documents so be sure to seek legal advice as needed.
Designating Primary and Secondary Beneficiaries
When it comes to beneficiary designation forms, you want to avoid gaps. If you don’t have a named beneficiary who survives you, your estate may end up as the beneficiary, which may not always be the best result.
Your primary beneficiary is your first choice to receive retirement benefits. You can name more than one person or entity as your primary beneficiary. If your primary beneficiary doesn’t survive you or decides to decline the benefits (the tax term for this is a disclaimer), then your secondary (or “contingent”) beneficiaries receive the benefits.
Having Multiple Beneficiaries
You can name more than one beneficiary to share in the proceeds. You just need to specify the percentage each beneficiary will receive (the shares do not have to be equal, but the total must equal 100%). You should also state who will receive the proceeds should a beneficiary not survive you.
In some cases, you may want to designate a different beneficiary for each account or have one account divided into subaccounts (with a beneficiary for each subaccount). You do this to allow each beneficiary to use his or her own life expectancy in calculating required distributions after your death. This, in turn, can permit greater tax deferral (delay) and flexibility for your beneficiaries in paying income tax on distributions.
There are two ways in which your retirement benefits could end up in your probate estate. Probate is the court process by which assets are transferred from someone who has died to the heirs or beneficiaries entitled to those assets.
First, you might name your estate as the beneficiary. Second, if no named beneficiary survives you, your probate estate may end up as the beneficiary by default. If your probate estate is your beneficiary, several problems can arise.
If your estate receives your retirement benefits, the opportunity to maximize tax deferral by spreading out distributions may be lost. In addition, probate can mean paying attorney’s and executor’s fees and delaying the distribution of benefits.
Your Spouse as a Beneficiary
When it comes to taxes, your spouse is usually the best choice for a primary beneficiary.
A spousal beneficiary has the greatest flexibility for delaying distributions that are subject to income tax. In addition to rolling over your 401(k) or IRA to his or her IRA, a surviving spouse can decide to treat your IRA as his or her own IRA. This can provide more tax and planning options.
If your spouse is more than 10 years younger than you, then naming your spouse can also reduce the size of any required taxable distributions to you from retirement assets while you’re alive. This can allow more assets to stay in the retirement account longer and delay the payment of income tax on distributions.
Since everyone’s situation is unique, it’s important to discuss these issues with a reputable estate attorney to get the best possible advice for your specific circumstance.
The AIA Trust is here to help
The AIA Trust offers retirement savings plans and distribution options through Equitable Financial Life Insurance Company (Equitable Financial) to assist you in achieving your retirement goals. Plans can be established for one-person firms (or components)—or for many employees—utilizing a variety of retirement savings and distribution vehicles. Equitable Financial can assist you toward achieving your goals based on 51* years of experience working with association members and over 25 years with AIA architects. Equitable Financial can help you review your options and offer you choices that can help alleviate the burden of establishing and managing a retirement savings plan. It’s one of the ways that the AIA Trust makes it easier for you to focus on doing what you do best: architecture.
Please call 800-523-1125 to speak with a Retirement Program Specialist or visit www.TheAIATrust.com/retirement-plans/ to learn how you can start saving.