Selecting Beneficiaries for IRAs and 401(k) Accounts

​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.

Gary Begnaud

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