by: Cecilia Fernandes and Robert N. Polans, CPA, MT, PFS, ChFC
The COVID-19 pandemic unexpectedly took the lives of many loved ones. It made many of us stop and reflect deeply about what is most important: health and family! With that in mind, there is no better time than now to check your beneficiary designations related to your retirement plan accounts, traditional IRAs and Roth IRAs, tax-deferred annuities, and life insurance policies, to ensure they are all up to date and in line with your overall estate distribution goals.
Many people mistakenly believe that their last will and testament will direct where their assets go after they pass away. This is only true, however, for “Probate Assets.” Non-probate assets, such as qualified retirement plan assets, traditional and ROTH IRAs, tax-deferred annuities, life insurance policies, and assets within most intervivos trusts, are directed only by your beneficiary designation. An exception to this occurs if you fail to complete a beneficiary designation or if you specifically name your estate as your beneficiary within your beneficiary designation. Sometimes these non-probate assets still go to your estate and are directed by your will despite there being a named beneficiary. This occurs when a named beneficiary pre-deceases you, and when you did not update the beneficiary designation during your lifetime and, hence, did not name contingent beneficiaries. Always name contingent beneficiaries!
If you will leave behind significant non-probate assets including retirement accounts, also consider as part of your overall estate plan, whether these assets should be directed into trusts to benefit your beneficiaries. Trusts can provide a level of asset protection including protecting a beneficiary’s inheritance from attacks from litigation or creditors, protection of assets in divorce proceedings, from reckless spending habits, or from poor investment decisions made by the beneficiary. Trusts can also keep assets within the family if a premature death occurs of a beneficiary.
It is imperative to work with your estate and trust attorney and your tax advisor - when a trust is named as the beneficiary of a retirement plan or any IRAs, as the new provisions of the SECURE Act (see below) have shortened the payout periods for those accounts and can dramatically affect the level of taxation when passing into or through a trust.
In January, we published a two-part blog series discussing the SECURE Act which you can read here: Part I and Part II. Retirement account owners who die after December 31, 2019 generally must be distribute to designated beneficiaries within 10 years after death, unless the designated beneficiary is an “eligible designated beneficiary.” The 10-year rule applies whether the owner dies before, on, or after the required beginning date (RBD). This rule applies to both Roth IRAs and Roth 401(k) accounts.
Under the new 10-year distribution rule, most advisors have interpreted this new rule to mean annual distributions to the beneficiary are not required. The account can continue to grow tax-deferred with compounding for 10 years and then be distributed in its entirety at the end of the 10-year period. See our prior blog where the IRS appears to have mistakenly applied a required minimum distribution requirement during the first nine years of the 10-year period in their annual update to IRS Publication 590-B. The IRS initially announced it was aware of its error. It then updated Publication 590-B in May 2021, but still failed to fix its interpretation as of the writing of this blog. We will report any future changes to the IRS interpretation as they come. It would be best to avoid taking unnecessary distributions in 2021 until later in the year to give the IRS further opportunity to revise its interpretation.
The SECURE Act 10-year rule does not apply to certain “eligible designated beneficiaries.” Eligible designated beneficiaries include a surviving spouse, chronically ill or disabled beneficiaries, minor children of the account owner (up to the age of majority, or 26 if the child is still in school), and beneficiaries not over 10 years younger than the original account owner.
Best practice is to check your beneficiary designation regularly, perhaps once a year or upon big life events such as marriage, divorce, birth of a child or grandchild, and death of a beneficiary. Particularly after the recent pandemic, making sure your family and the people you care about most are taken care of, is imperative.
Naming beneficiaries for your assets requires thoughtful planning and discussions. We recommend that you talk to your tax advisor if you have questions about what would be best for you and your loved ones. To discuss how the changes brought about in the SECURE Act affect your retirement or estate plans, call on The Tax Warriors® at Drucker & Scaccetti for help. We are always prepared to help with this or any other tax-related matter.