Neglecting Estate Planning and Trusts can be Costly

Ambrose Bierce, a 19th-century writer known for his sardonic outlook, once remarked, ”Death is not the end. There remains the litigation over the estate.”  Bierce died long before the individual retirement account (IRA) and the 401(k) plan came along.

Estate Planning Aided by IRA and 401(k)s

IRAs and 401(k)s are retirement plans not subject to probate, even though they are part of an individual’s estate. Retirement plan assets pass directly to the account beneficiaries without a will. For this reason, it’s critical to correctly name your beneficiaries. By avoiding some common mistakes, you can potentially exercise greater control over who inherits the assets in your retirement plan.

Specificity Key in Naming Trusts, IRAs and 401(k)s

Unnamed Beneficiaries

It’s not uncommon for some investors to delay naming primary or secondary beneficiaries when they first set up an account, and they may forget to take care of it later. If no living beneficiaries are named, the consequences will vary according to the financial institution, but in most cases the money will be considered to be part of the account owner’s estate and subject to the applicable taxes.

Incorrect or Outdated Beneficiary Designations

The birth of a child, a change in your marital status, or the health status of your heirs can trigger the need to review your choice of beneficiaries. If you have minor children, you might want to consider setting up a trust and making it the beneficiary of your retirement plan. Otherwise, the state likely will control the money and turn it over to your kids in a lump sum when they reach legal age, regardless of any instructions in your will.

Overlooking Tax Consequences

IRAs and 401(k) plans can potentially be subject to income taxes and estate taxes. If the retirement plan hasn’t been structured properly or if your estate is the beneficiary, your heirs might collect a fraction of the original value after taxes. By taking the appropriate steps, you may be able to help reduce the impact of taxes and preserve the value of your accounts for future generations.

Ignoring the role of retirement plans in your estate planning can be costly. By periodically reviewing your retirement plan beneficiary designations, you may be able to exercise greater control over how your assets are distributed when you are gone.

Remember that distributions from traditional IRAs and 401(k) plans are taxed as ordinary income and, if taken prior to reaching age 59 ½, may be subject to an additional 10 percent federal tax penalty.

The use of the above approaches can involve a complex web of tax rules and regulations. You should consider the counsel of an experienced estate planning professional before implementing such strategies.  Before you take any specific action, be sure to consult with your tax professional.