3 Thing You Might Not Know About Beneficiary Planning

Until 2020, retirement accounts such as IRAs and 401k accounts were a pretty good asset to inherit and pass on to the next generation or the next.

Now, not so much.

On December 20, 2019, Congress enacted the Secure Act, a massive tax bill that made significant changes to retirement accounts and the rules for passing account funds to beneficiaries. Most of the changes in the bill took effect January 1, 2020, just twelve days after passage ─ thanks Congress! The biggest change was eliminating the ‘Stretch IRA,’ which previously allowed beneficiaries of inherited IRAs to use their own life expectancy to determine their required distributions each year.

Most beneficiaries ─ except for spouses, who have super-beneficiary status, and the new ‘eligible beneficiaries’ introduced by the Secure Act ─ now have 10-years to deplete the account, which might well be during their high income-earning years.

Of course, anything created by Congress is far more complicated than that. Only three years later lawmakers put their fingers back in the pot and passed Secure Act 2.0, which made many more changes to retirement accounts including big changes for business retirement plans.

By now you’ve noticed: the Government has its sights on your retirement funds. (U.S. retirement accounts currently hold more than $35 trillion dollars (most of it untaxed.)

Pay attention to these three things if you wish to have your retirement accounts transfer smoothly and with maximum flexibility:

1. IRAs are subject to four post-death distribution rules - depending on the beneficiary ‘classes’ and whether the IRA account holder passes before or after they began taking Required Minimum Distributions. One of these classes has five categories of its own. This is a minefield of complexity that only Congress could manufacture, and IRA fund administrators (banks and fund managers) often get wrong. Post-death distribution might be 10-years, 5-years, the old ‘stretch’ life expectancy table, a lump-sum, or something else. Knowing these rules in advance is good for you and your family.

2. The ‘Designated Beneficiary’ ─ the person(s) you name on your beneficiary form ─ will usually be the one to inherit your IRA. But the IRS allows limited changes to be made to beneficiaries even after you’ve passed. By whom, and how? By you! The period between the IRA owner’s death and September 30 of the following year ─ called the ‘gap year’ ─ allows for changing the beneficiary to someone else, but only someone you previously named as a beneficiary or a contingent beneficiary on your IRA form.

For example, Mary, wife of John, may inherit John’s IRA as the beneficiary but disclaim the inheritance in favor of their children(the Contingent Beneficiaries) because she does not need the money. This requires filing a legal form, and you should consult an attorney for disclaimers, which generally must be completed within nine months of the date of death. Beneficiary planning can be a powerful form of tax planning. Disclaiming can also be a good solution to complex family situations such as premature death of a beneficiary, disability, and divorce in favor of the couple’s children.

3. Beware of Fees! This lesson came from personal experience. In our family, three children inherited two small IRAs from our father, who began required distributions many years earlier. None of us wished to keep a small, inherited IRA with required annual minimum distributions; we were going to close the accounts. Three things happened next, all unpleasant. First, we were (each) charged an account transfer fee – on an inherited IRA of a long tenured customer.

Three inherited accounts, three transfer fees. Second, when we closed the accounts, we were (each) charged a larger account closing fee. If these petty fee grabs were not enough, the IRA held numerous funds all with small balances, and we flipped through pages of fund balances, reinvested shares, gains, and losses to calculate basis, which was partially supported by Dad’s prior tax returns with little support from the broker. Save your family the unpleasantries: if you hold IRAs with broker-dealers, now might be the time to examine the fine print in your brokerage agreements or to ask about fees on fund transfers.

IRA planning can be complicated and has many tax traps.

Have questions about your beneficiary plan?

Talk to your financial advisor about your plan, the risks to you and your beneficiaries, fees, and proper documentation.

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