An increasing number of Americans are growing the bulk of their wealth through retirement accounts (such as IRAs and 401(k)s), especially as defined benefit pension plans have become increasingly rare. Few people are expecting to survive on Social Security exclusively.
With this investment comes to an important question – what will you do with the remainder of your savings, should you die before it is spent? We cannot take much with us into the grave. Bank accounts, investment accounts, assets, properties, and trusts are bequeathed upon death either per your instructions or state law.
Retirement benefits and accounts are some of the few assets that have the luxury of entirely skipping the probate process, provided you've named beneficiaries in your account or made it part of a trust built to make payments to your family on your behalf. Sometimes, it is a little more complicated than that. There are tax issues to consider, and who best to name as beneficiary.
An estate plan sounds extravagant, and most people picture the idea of a decedent's estate to be terminology reserved for artists and the exceptionally wealthy. But estate plans can range from a simple will to a series of documents meant to preserve a loved one's finances and dignity while suffering from a chronic health condition.
Whether you leave behind a modest sum or a large fortune, an estate plan matching your means in scope and intent is almost always a good idea because the alternative – dying intestate – means that the division of your assets and accounts is entirely out of your hands. Most estate plans aim to accomplish two things:
State estate tax exemptions and tax rates differ, with some states – like California – having no state estate taxes. The federal estate tax, on the other hand, is by far the highest potential cost on any person's accrued assets and property and currently only affects estates with assets and property over a total of $11.58 million for individuals in 2020 (and double that for estates using a combined marital exemption).
However, this exemption is historically very high (it is three times the estate tax exemption we had in 2009, for example). It may lower in the coming decades, affecting a much greater number of Americans. Estate plans can help minimize the impact of estate taxes on your savings, often by:
Estate plans can also help you better control how your assets and accounts are distributed after your death. While retirement benefits and accounts are not subject to a will – and should not be, so long as you named your own primary and contingent beneficiaries – there are other ways of fine-tuning the bequeathment process. Usually, the retirement account itself determines how distributions occur after death. Beneficiaries typically gain access to the account, with the option of either:
Distributions are taxed at the beneficiary's income tax rate depending on the kind of retirement account. Whether the account holder died before or after the beginning date of their required minimum distributions (RMDs), and whether the sole beneficiary is their surviving spouse.
However, if the account's beneficiary is a trust – an estate planning instrument – rather than a human individual, the rules can change drastically. Retirement account trusts may be incredibly beneficial and can help some estates preserve the value of an account and better control its distribution to multiple beneficiaries, but maybe too complex or expensive to maintain for others, making it essential to consult an estate planning professional beforehand.
For example, naming a trust as beneficiary can help preserve the IRA's value in the long-term by making annual distributions to the trust's beneficiary, rather than giving them a lump sum they might not use wisely. A retirement account can also be used to finance a trust used to benefit a special needs child. Special trusts can also be set up to avoid having a retirement account's total assets be folded into a surviving spouse's estate for tax purposes.
Regardless of whether retirement benefits are distributed during retirement, in a lump sum after death, as an inherited IRA with required minimum distributions, or through a trust, the contents of a retirement account are typically taxed once they are distributed, as assets held in qualified plans, and IRAs both generate no tax liability.
The tax rate on retirement account distributions is the same as the account holder or beneficiary's income tax rate. But a significant exception applies to Roth accounts. Roth IRAs or Roth accounts can be used to make tax-free withdrawals and distributions. Some important things to note are:
While there are penalties for early distributions, it should be noted that the CARES Act allows Americans to withdraw as much as $100,000 from a traditional or Roth IRA without paying the penalty if they have been affected by COVID-19. Otherwise, there are penalties for making withdrawals before the account has reached a certain age before 59 ½.
Conversely, once you reach age 70 ½, the account is expected to take the required minimum distributions to avoid penalization. Similarly, beneficiaries who do not cash out their inherited retirement benefits must make required minimum distributions after December 31 on the year that the account holder died.
Founded in 1975 by L. Rob Werner and serving California for over 48 years, our dedicated attorneys are available for clients, friends, and family members to receive the legal help they need and deserve. You can trust in our experience and reputation to help navigate you through your unique legal matters.
Whether you need help creating a living trust or navigating probate, our living trust law firm's compassionate team of estate planning lawyers and probate lawyers are here to help you and ready to answer your questions.
Our goal is to make your case as easy as possible for you. Hiring a lawyer can be a daunting task, but it doesn’t have to be. From the moment you contact our firm, through the final resolution of your case, our goal is to make the process easy and understandable. We cannot change the fact that probate is a long and complicated process, but through our Werner Law Firm Difference, we strive to go out of our way to keep you informed of your case through every step of the way. We are constantly refining our processes and procedures for a more streamlined and calm client experience. Our goal is to have you feel like a burden was lifted from your shoulders, and that we made the whole process an easy one
If you're dealing with a legal matter, we urge you to schedule a free initial appointment today and join the many satisfied clients who have contacted Werner Law Firm.
23 Corporate Plaza Dr., Suite 150
Newport Beach, California 92660