Who should you name as the beneficiaries of your pre-tax retirement accounts, and why?

You are working on your estate plan, and trying to figure out who you should name as the beneficiary of your 401k account and IRAs. Simple – the kids, right? Not so fast. Who should be your 401k beneficiaries? Who should you name to inherit your IRAs? If you want to minimize taxes, who you name as your beneficiaries matters. Watch this video to understand non-spouse beneficiary distribution rules for inherited pre-tax IRAs and “regular” pre-tax 401ks.

Understanding the rules from an income tax standpoint might help you decide who to name as your beneficiary. Who inherits the assets you hold in your various retirement accounts could have a big impact on the amount of money that is ultimately received by your heirs vs given to Uncle Sam.

0:00 Welcome
0:35 Why is it important for IRA beneficiaries to be tactical about taking distributions from an inherited pretax account?
0:55 Did the SECURE Act of 2019 affect inherited pretax asset distributions from a 401k account?
1:03 What was the stretch strategy as it applied to IRA beneficiaries or inheritors of a 401k account?
1:35 What is the current law around taking distributions from an inherited pre-tax retirement account?
1:49 How do these beneficiary distribution rules affect what we pay in taxes on inherited 401k and IRAs?
2:04 Are there strategies to maximize the money beneficiaries will receive from an inherited pre-tax account and minimize taxes?

The beneficiary distribution rules for inherited pretax 401k accounts and IRAs when your spouse is not named as beneficiary are important for income tax and estate planning purposes.

The longer a beneficiary is able to wait before taking distributions from an inherited pretax account the longer the assets can grow without being taxed. Waiting longer to take a distribution allows the beneficiary to be more tactical about when to take distributions.

Dec. 2019 SECURE ACT eliminated what was known as the stretch strategy, which had allowed non-spouse beneficiaries to take distributions from an inherited 401k account or IRA at a rate based on their life expectancy. The stretch strategy also allowed non spouse beneficiaries to pass on these tax benefits (tax deferred growth) from one generation to another, while having a larger window of time to take advantage of their tax deferred growth. Also, it potentially cut the income taxes due on Required Minimum Distributions RDAs, from these accounts because younger beneficiaries, like children or grandchildren, may be in a lower tax bracket.

Current law (as of March 2022) says that non-spouse beneficiaries who inherit a pre-tax retirement account are required to withdraw all money from the inherited account within 10 years of the death of the original account owner. This means distributions from an inherited account will be larger and possibly subject to higher income tax rates, resulting in less inherited money received.

However, there are a number of tax and estate planning strategies you can implement to maximize the money your beneficiaries will ultimately receive. If you’d like to learn more about these strategies, including choosing who will inherit your retirement accounts, we would love to have a conversation with you.

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Maximizing the money your 401k and IRA beneficiaries inherit is an important consideration when planning for retirement. Pre-tax retirement accounts, such as 401ks and IRAs, can be a valuable tool for saving money for the future, but they also come with many rules and regulations that must be followed in order to ensure that your beneficiaries receive the maximum benefit possible.

One of the easiest ways to maximize the money your beneficiaries inherit from your pre-tax retirement accounts is to make sure that you have named them as beneficiaries in the first place. Many people forget to update their beneficiary designations after significant life events, such as marriage or the birth of a child. Failing to do so can result in your retirement account assets going to the wrong person or winding up in probate, which can be lengthy and expensive.

Another way to maximize the money your beneficiaries inherit is to take advantage of the “stretch IRA” strategy. This involves naming a younger beneficiary, such as a child or grandchild, who can then take distributions from the account over their own lifetime instead of being forced to withdraw the entire amount within five years of the account owner’s death.

For example, let’s say that you have named your 35-year-old daughter as the beneficiary of your Traditional IRA, which has a balance of $500,000 at the time of your death. Under the stretch IRA strategy, your daughter can take distributions over her own lifetime, which could add up to hundreds of thousands of dollars in tax-deferred growth over the years.

Another option for maximizing the amount your beneficiaries inherit from your pre-tax retirement accounts is to convert a portion of the account to a Roth IRA. This will require you to pay taxes on the converted amount, but the benefit is that your beneficiaries can inherit the Roth IRA tax-free, as long as they follow the distribution rules.

While there are many ways to maximize the money your beneficiaries inherit from your pre-tax retirement accounts, it’s important to work with a financial planner or advisor who can help you navigate the complex rules and regulations. By taking the time to plan ahead and make wise decisions about your retirement accounts, you can ensure that your loved ones will be well taken care of long after you’re gone.