Managing your retirement is crucial not just for you but for your family as well. While your retirement plan is primarily focused on covering your expenses when you reach old age and have no income of your own, it is also aimed to help your family be well taken care of once you pass away. The retirement funds don’t just magically disappear if a retiree passes away early into retirement. Let’s see what the options are.
Understanding ERISA
The federal law known as the Employee Retirement Income Security Act of 1974 (ERISA) establishes minimum requirements for most voluntarily organized retirement and health plans in the private sector to safeguard participants in these plans. Any benefits the retirement plan owner would be entitled to upon death get distributed to the participant's designated beneficiary under the plan's terms (whether a specific sum or a periodic payment of some sort).
ERISA covers the surviving marital partners of the past retiree but only if the accounts were vested to them by the primary owner. The level of protection relies upon the terms of the plan. Again, it depends on whether the beneficiary dies before or after the pension benefit is ready (the starting date of the annuity).
If a participant dies before the annuity starting date
If you pass away before receiving retirement income, your designated beneficiary is entitled to the value of all account balances. This includes all investment funds under any payment method chosen by the beneficiary and permitted by your financial service provider. This income is subject to federal income tax regulations.
If a participant dies after the annuity starting date
Usually, benefits that would have been due to a deceased participant in a retirement plan get paid to that participant's designated beneficiary under the plan terms (whether a lump sum or an annuity).
The money in the account can be inherited by their spouse (or other beneficiaries) and used as they see fit. If they want to take over ownership of an inherited retirement plan, they must ensure they comply with all the rules set by the IRS.
Possible beneficiaries
You can choose to name a beneficiary when you sign up for a 401(k) plan or start an IRA. A beneficiary is a person or even a group of people to whom a retirement account will get paid out when the account holder passes away. Upon the account holder's passing, beneficiaries take control as a custodian of the inherited account. You can assign anyone as a beneficiary or name nobody.
To make changes to beneficiaries, you must obtain the official consent of the current beneficiary and submit it to your retirement plan provider. If not, they will continue to be the account's beneficiaries.
Spouse
Federal law has many protection mechanisms for spouses.
Even after a divorce, a spouse with beneficiary rights may continue to hold them. If not specified in the divorce settlement, several states expect written authorization from the ex-spouse before they get removed as beneficiaries.
Other beneficiaries
As previously explained, you can name anyone as a beneficiary of your retirement account. There is no requirement for consent if you are single. You can nominate a beneficiary for your retirement plan by naming your kids, siblings, parents, a close friend, or even a charity.
Remember, if you are married, your spouse must still give written consent before you can name anybody else as a beneficiary, including your children.
In case of no beneficiary
A sudden passing can leave a retirement plan incomplete. Retirement funds are considered to be a part of a person's estate if no beneficiary is named. So, the retirement plan assets must go through probate, a long process for those with rights to your estate and benefits. Your money might not go where you would have preferred if you did not name a beneficiary.
Retirement fund distribution options
There is some flexibility and some limitations when it comes to the distribution of the funds. You can provide beneficiaries with instant access to the fund or keep the funds growing.
Required minimum distributions
Required minimum distributions can be the wisest choice if you plan to sustain your beneficiary for a longer time frame. You can choose to have your beneficiary receive equal distributions over a certain period, just like you do when you reach the age of 59 ½. No additional penalties will apply, but income tax will still be a factor when receiving these payouts.
Distributions by lump-sum
Beneficiaries can cash out your 401(k) account in full in a single transaction. Many plans choose to do this automatically because it relieves them of the continuing responsibility of keeping an account for an employee who has left the firm.
There won't be any further penalties for doing so, but the full money will be liable for income tax and, if the estate is sizable (estate tax).
Rollover distribution
Beneficiaries can choose to roll over a 401(k) into a new or existing inheritance account instead of withdrawing the entire value of a 401(k).
Consolidated 401(k) accounts operate just like they would if they were in the original account holder's name. The rollover won't result in any tax obligations. Taxation doesn’t take effect until the money distribution begins.
If the 401(k) administrator requests that the entire sum gets distributed upon the account holder's death, this action is considered a salient alternative.
Retaining in the original ownership
Another option is to simply keep the original owner's name if the plan administrator permits it. Leaving the account as is will delay all required action and the beneficiary must begin receiving minimal payouts by the time the decedent turned 70½.
A recent mandate: To boost federal tax revenue the government introduced the SECURE Act which mandates that the majority of beneficiaries have to withdraw all funds in a 401(k) ten years after the account holder passes away.
Summing up
Maintaining a retirement account effectively requires more than just setting it up initially and periodically checking your statements. An often forgotten critical step is appointing a beneficiary in case you pass away before using all your money. Share your intentions with your loved ones and create a plan for distributing your funds to secure their future.
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