It’s easy to think of an estate plan as simply a will, a trust, or some power of attorney documents. While these are an imperative part of any estate plan, the work is not complete once the documents have been signed. The individual will want to be sure that they have brought their beneficiary designations for certain assets (namely life insurance policies and retirement accounts ) in line with the overall scheme of their estate plan.
Life insurance can often be a large part of an individual’s estate plan. They might intend to use the life insurance policy as a way to make a large gift to one or more beneficiaries, or they might intend to have their executor use the proceeds from the life insurance policy to pay estate taxes or other expenses of the insured’s estate. If a proper beneficiary designation is not put in place before the insured individual dies, the proceeds might not pass as they intended (i.e. they could pass to their estate or to a beneficiary or group of beneficiaries that the insured did not intend to benefit).
For retirement accounts, the implications for failing to have a named beneficiary can be much more dire. Retirement accounts, such as IRAs and 401(k)s, might be an individual’s single biggest asset, and that individual will want to be sure that the proceeds from those accounts end up with the right beneficiaries, and that the beneficiaries receive the greatest tax benefit possible. A proper beneficiary designation allows the beneficiary to “stretch” any required minimum distributions over the life of the beneficiary (as opposed to the life expectancy of the deceased individual).
Ideally, the account owner would designate his or her spouse as the beneficiary. The spouse is then able to roll the retirement account into their own retirement account and stretch the distributions according to their life expectancy. Even if an account owner is not married, it is still preferable to designate a non-spouse beneficiary as opposed to not naming a beneficiary at all.
In the case of a non-spouse beneficiary, if the original account owner dies before age 70 ½, the required minimum distributions will be based on an IRS table that takes into account the beneficiary’s life expectancy. If, on the other hand, the original account owner dies after age 70 ½, the required minimum distributions are based on an IRS table that takes into account the longer of the beneficiary’s life expectancy or the account owner’s life expectancy. If an account owner dies before age 70 ½ and fails to name a beneficiary, then the beneficiaries are determined by the account agreement. Such beneficiaries will be required to withdraw all of the account within five years of the original account owner’s death. Moreover, the required minimum distributions will be based on the account owner’s life expectancy (which is likely to be shorter, perhaps significantly so, than that of the beneficiary).
The distributions that the beneficiaries eventually receive are income taxable to the beneficiaries. Unfortunately, this cannot be changed , but by having beneficiary designations in place, the income tax burden can at least be mitigated to some extent.
First, it isn’t enough to just name a primary beneficiary. An account or policy owner should be sure to name contingent beneficiaries as well in the event the primary beneficiary is unable or declines to accept the benefits. Second, beneficiary designations do not have any bearing on the inclusion of the value of the account or policy in the owner’s gross estate for estate tax purposes; in fact, the value of life insurance policies and retirement accounts are typically included in the owner’s gross estate. The designating of beneficiaries is more of an income tax play as opposed to an estate and gift tax play. Finally, it is important for an account or policy owner to understand that their estate planning attorney can assist with finding the necessary institutions to get the proper designations in place. and help you with the forms that the institutions are likely to provide.