Financial Planning 101 – Naming a 401k Beneficiary

In this installment of financial planning basics articles, we discuss an aspect of setting up and managing your 401k account that a lot of people ignore or don’t put a lot of thought into – beneficiary designations.

The definition of a beneficiary is someone, “who receives help or advantage from something.”¹  When you become a participant in a retirement plan, you are asked to complete a beneficiary designation form, which identifies who will inherit (or benefit from) the account in the event of your death. For most married people, the automatic assumption is that the account owner’s spouse will be the beneficiary. It is also a legal requirement per ERISA that any allocation of less than 50 percent to a current spouse beneficiary will require the spouse to sign a waiver. You also have an option of naming contingent beneficiaries: that is those who will inherit if your primary beneficiary predeceases you or chooses to decline the inheritance.

Many plan participants ignore or skip the beneficiary designation, which can ultimately lead to delays and potential additional costs if the account needs to go through probate. In general, probate is the process of determining inheritors of an estate and may not be an issue, depending on the size of the estate and state requirements. An easy bypass for retirement plan assets is naming an individual as beneficiary. 

More than adding time, cost, and complexity to settling your estate, not having updated beneficiary designations can result in your assets going to people you hadn’t intended to benefit. The classic example is of the spouse that never updated their beneficiary designations after remarrying, leaving considerable assets to their ex-spouse. Regardless of how amicable a divorce you may have, it is always a good idea to make sure that you are providing for the people who are sharing your life now, as well.

You may be considering naming your kids as beneficiaries so that they are assured of having some assets should you die prematurely. Keep in mind that minor children cannot be named as direct beneficiaries. So, if this is your intent, you may have to do some additional estate planning and create a trust and trustee who will manage the assets until the children come of age.

You should also consider how choosing a beneficiary can dictate how these assets are eventually distributed. The 2019 SECURE Act effectively eliminated the ability of certain beneficiaries to take minimum distributions from qualified retirement plans based on age. If you inherited a 401k from someone other than a spouse, in most cases you now must distribute the entire balance within 10 years. There’s a lot more complexity to it than that and a few exceptions to the rule, but the bottom line is that inheriting a significant tax-deferred asset could result in a lot of taxable income over a relatively short period of time. A spouse still can rollover retirement assets to their own IRA and take minimum distributions based on their own age.

While it might seem premature to think about who will inherit your 401k account, ignoring the beneficiary designation at the start, or not periodically reviewing and updating beneficiaries, you could be unwittingly creating a challenge for the people you care most about at a time when they need fewer challenges.

And the same can be said for all accounts that have beneficiary designations. The designation of a beneficiary for an IRA or life insurance policy is an important part of directing the disposition of your assets at death. By failing to name a beneficiary, the estate automatically becomes the beneficiary, and the balance may be fully taxable at death in the case of an IRA. Each custodian and provider may have different rules and procedures that govern the assets they control, so you should carefully read all documents and have signed and dated copies from your custodian indicating that they have your most recent forms. Be sure to also coordinate your beneficiary designations with your estate documents because beneficiary designations override wills.

If you are interested in more financial planning basics, check out our previous articles at westfinancial.com/News/Financial Planning Focus.

Meet Kristan L. Anderson, CFP®, CEBS^®  »

Read the May 2024 Financial Planning Focus:

• “Are You Expecting Too Much from Your Target Date Fund” by Kristan L. Anderson, CFP®, CEBS® »
• “Long-Term Care” By Angel Irazola »
• “Tax Policy: The Next Political Battle” by Matt Cohen, CFP®, CIMA® »

SOURCES

¹https://www.merriam-webster.com/dictionary/beneficiary
 

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