Reviewing Beneficiary Designations

A crucial part of any estate plan is the regular review of the beneficiaries listed on assets, and recent law changes require careful consideration when naming beneficiaries on assets such as IRA’s and 401(k) plans.

The SECURE Act went into effect on January 1, 2020.  Before implementation of the act, distributions from Qualified Plans such as IRA’s and 401(k) plans were able to be “stretched” over the life expectancy of a beneficiary.  This “stretch” allowed the assets in the Qualified Plan to continue to grow tax free for the beneficiary’s life, with smaller required distributions.

The SECURE Act changed these rules so that, for most non-spouse beneficiaries of Qualified Plans, distributions must be taken out over a period not exceeding 10 years.  Exceptions to the 10 year rule also exist for (1) minor children and (2) disabled or chronically ill beneficiaries.

Also, after implementation of the SECURE Act, when naming a trust as beneficiary of a Qualified Plan, only certain trusts qualify for the 10 year payout.  If a trust does not qualify for the 10-year payout, assets in the Qualified Plan must be paid out over 5 years.

A trust must be classified as a “see-through” trust in order to receive the maximum 10-year payout.  A “see-through” trust is a trust of which all beneficiaries can be identified according to IRS rules, and a trust which has a charitable beneficiary cannot be a see-through trust.

One problem with leaving Qualified Plan assets to a trust, however, is the rate of income tax imposed upon plan proceeds retained by the trust and not distributed to a beneficiary.

Trusts reach the maximum income tax brackets very quickly, so the income taxed to a trust frequently has a much higher effective tax rate than funds left to an individual.

In addition, Estates and minor beneficiaries should not listed as beneficiaries of Qualified Plans, as either can cause problems including subjecting the assets of the Qualified Plan to the five-year payout rule.

Regular review of beneficiary designations allow us to (1) review the necessity of leaving assets to beneficiaries in trust, (2) ensure that those trusts are properly drafted in order to receive funds from Qualified Plans, and (3) save income taxes to the extent possible.