One of the critical decisions to be made regarding any IRA or 401(k) account is selecting a beneficiary for retirement benefits. This differs significantly from how beneficiaries are designated for insurance and other types of inherited assets such as stocks, real estate, and bank accounts. With the latter, the assets typically pass through with no taxes being assessed. However, this is not the case with traditional IRAs and pre-tax 401(k) plans. Beneficiaries are responsible for ordinary income taxes on these types of plans (unless they are set up as Roth IRAs or Roth 401(k) accounts).
The act of entering participation in a 401(k) or opening an IRA comes with documentation requirements that include designating beneficiaries (changes are made to this by completing a new beneficiary designation form). Whoever is named, a trust or will with differing instructions does not override this beneficiary designation (although state or federal statutes may give spouses special rights). Thus it makes sense to undertake a review of the beneficiary designation form every few years and ensure that all estate documents are in agreement, accurately reflecting changes in life circumstances. Without a named beneficiary, the estate itself may wind up as the beneficiary. A lengthy probate process may begin that leads to higher taxes and fees assessed, and money held in limbo until probate is completed. When selecting beneficiaries, it’s important to think carefully and consider those, whether child, spouse, niece, or caretaker, who will receive the most benefits from one’s assistance. One way of avoiding any gaps is to name a primary beneficiary (or beneficiaries), as well as secondary (contingent) beneficiaries. In cases where the primary beneficiary passes on before one does, or declines to inherit the assets, funds are directed to the secondary beneficiaries. If the retirement funds are passing to a minor (generally under age 18), it’s important to assign a custodian as well. This person or entity manages the inheritance until a specified age is reached. Failing this, the state may step in and select a custodian that may prove to be a less than ideal choice. One distinguishing feature of 401(k) plans centers on spousal beneficiary rights. With such plans, unless the spouse signs a waiver, he or she is considered the beneficiary. This can become complicated in cases of divorce and the spouse named being different than the current spouse. An example is a person who, following divorce, changes the 401(k) designation to his children and subsequently remarries. When he dies, because he did not secure a waiver from his second spouse, the money does not pass to the children (as designated) but to the current wife. The upshot of this type of contested situation is that it pays to undertake full beneficiary reviews following divorce, marriage, or the birth of children, and make updates that reflect one’s current preferences and life situation. It’s worth noting that it’s possible to name multiple beneficiaries who share the distributed funds. This is typically accomplished by specifying percentage distributions, but may also be accomplished by splitting one account into several subaccounts, with one beneficiary assigned to each. The SECURE Act, passed in 2019, stipulates that inherited retirement accounts must be emptied within a decade. The option of taking distributions in the longer term, based on life expectancy, no longer exists.
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Financial literacy is making responsible or reasonable decisions about saving, spending, investing, borrowing, and earning. According to an investor education foundation study conducted by FINRA, four out of five young adults cannot pass a financial literacy quiz. These statistics underscore the need for more children to be taught financial literacy. Similarly, CBI Economics has demonstrated that financial literacy helps to raise early-career earning prospects by about 28 percent. This study further showed that students or young people who are financially literate are more likely to be entrepreneurs.
Managing one income requires a skill set that includes knowledge of mathematics, emotional intelligence, and budgeting. According to the Chief Executive of National Numeracy, Sam Sims, confidence with numbers is a non-negotiable life skill, particularly regarding money. Consequently, Cambridge University published a study demonstrating that people develop core financial skills at seven. The study showed that people develop the core behaviors that will determine their financial culture at a very young age. One major reason it is important to teach your children financial literacy is that it helps them grow into financially confident adults. According to a 2022 report by CNBC, 50 percent of American adults struggle to have $400 in savings to cover contingency spending. When children are taught how to spend and save, they learn to establish a good relationship with money early on in life, a skill useful to them as adults. This is important because finances are often precarious, and preparing for emergencies like car repair, healthcare, and property damage is important. In 2020, there was a 24 percent rise in the number of hospital emergency room visits for mental health among children aged 5 to 11. Similarly, in 2018, 68 percent of kids between the ages of eight and 16 reported worrying about their parents' financial situation. Psychologists have now concluded that money affects kids much more than previously believed when they gain knowledge about mental health. It also seems sense that economic concerns would impact children, as they can mirror adults' stress. Similarly, financial literacy is important for children because money is everywhere and needs to be managed properly. Financial literacy helps children understand that adults are not entitled to money. Instead, one works for money. This is important because it teaches kids not to throw tantrums when they do not get the toys or privileges they want. According to the Junior Achievement Survey, about 54 percent of teenagers have no idea how to navigate their financial future. This is particularly important because young adults set a trend for their financial future in their late teens and early twenties. Research by the University of Wisconsin Maidson revealed that financially literate children can avoid costly mistakes and death traps early enough in their young adult life. This means they will be more inclined to avoid payday loans with exorbitant interest rates. You must use everyday situations instead of abstract and sophisticated financial concepts to teach your children financial literacy. For instance, while paying utility bills, you can teach them the importance of budgeting and how it makes it easier to categorize expenses. Also, several mobile applications and technologies provide simplified resources. |
AuthorGary Begnaud - EVP of Janney Montgomery Scott Office in New Jersey Archives
June 2024
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