By Attorney Amanda N. Follett, Schloemer Law Firm, S.C.
Are my retirement account (401(K), IRA, etc.) beneficiaries set up correctly?
I get this question at least once a week, and like most things in the law, my answer usually is “well, it depends.”
If they are not, improper beneficiaries can lead to improper distributions, confusion, or accelerated taxes. This is not something you should take lightly or procrastinate on.
So, who should be listed as a beneficiary? The answer depends on the situation – the size of your retirement accounts, the age of your beneficiaries, whether you have a trust, and a host of other factors. Each situation should be discussed with your attorney and financial advisors.
If you have a trust, funding your Trust is a crucial part of your estate planning, but that does not automatically mean your Trust should be named as the beneficiary of retirement accounts.
Depending on the situation, we may be recommending our clients utilize individually named beneficiaries on IRAs rather than the Trust. In other words, if a client has a trust, we may recommend a spouse, children, or other beneficiaries be named as the beneficiary rather than the trust.
Individually names beneficiaries can be preferable, depending on the situation for a couple of reasons:
- Payment of Debts. The trust document usually says that the trustee should pay all debts. So, if a retirement account is paid to the trust, it is available to pay creditors first. Under 815.18(3)(j) Wis Stats, a retirement account is exempt from execution by a creditor. Naming the trust as a beneficiary removes this protection – it makes an “exempt” asset not exempt. (Note, there are similar exemptions for life insurance proceeds and annuities.)
- Access Timing. Individually named beneficiaries can allow for quicker access. The trustee of a trust should generally make no distributions to beneficiaries until after a 4 month creditor claim period has expired. If the beneficiary is an individual, there is no waiting period.
- Timing of Distributions. There are special rules that allow beneficiaries of retirement accounts to “stretch” out distributions to delay taxes. My blog from earlier this year discusses the new SECURE Act and the stretch rules more in detail: CLIENT ALERT: The SECURE Act Impacts Retirement & Wealth Transfer Planning. In broad terms, a spouse named as a beneficiary on a retirement account can stretch distributions out over lifetime, and an adult child can stretch distributions over ten years.
If the Trust is the beneficiary, the retirement account administrator may deny the ability to stretch out distributions or the trustee may distribute all funds, which would accelerate the payment of taxes.
- Decision-making. If individuals are named as beneficiaries rather than a trust, this would allows the individual beneficiaries to make their own choices for their share, for example: how it is invested, where it is invested, with whom it is invested, how and when discretionary non-mandatory distributions are made. If the Trust is named as a beneficiary, all these decisions may be made by the Trustee.
NOTE, however, this does not mean individuals should be named rather than a trust in all situations. If you have minor children or beneficiaries with special needs, the pros and cons of different approaches must be reviewed individually before making a decision.
Originally published: January 7, 2021.
More Important Reading
- Estate Planning for Mixed Families and Second Marriages
- Your Family Business Succession Plan
- Time Marches On: Do I need to Update My Estate Plan?
Disclaimer: The information contained in this post is for general informational purposes only and is not legal advice. Due to the rapidly changing nature of law, Schloemer Law Firm makes no warranty or guarantee concerning the accuracy or completeness of this content. You should consult with an attorney to review the current status of the law and how it applies to your unique circumstances before deciding to take—or refrain from taking—any action. If you need legal guidance, please contact us at 262-334-3471 or [email protected].