How Retirement Planning Affects Estate Planning

Most Michigan residents have some form of retirement savings. The most common types of retirement accounts are IRAs, 401(k) plans, and Roth IRA plans. Each has specific rules governing how and when withdrawals are made. In addition, there are significant estate planning implications for handling retirement accounts.

Is an IRA a Probate Asset?

Unlike most personal property that passes under a person’s will or living trust, retirement accounts usually have designated beneficiaries. If you have an IRA, for example, you can name a primary and contingent beneficiary. Upon your death, the account passes automatically to the primary beneficiary if he or she survives you; otherwise it goes to the contingent beneficiary.

Any such beneficiary designation overrides any contrary provision in your will or trust. This is because a retirement account is not considered an asset of your probate estate or trust unless you specifically name it as the beneficiary. If you fail to name a beneficiary, or all of the designated beneficiaries die before you, the retirement account will then be considered a probate asset. It is a bad idea to name your own estate as beneficiary, however, for tax reasons.

The Tax Implications of Inheriting a Retirement Account

So what are those tax reasons? As you probably know already, with a traditional IRA or 401(k) plan the account owner makes tax-free contributions while they are working. Upon reaching retirement age (usually 70 years and 6 months), the owner must make annual withdrawals, which are taxed at that time. A Roth IRA works in reverse: contributions are taxed when made, not upon withdrawal.

Now, normally when someone inherits property it is not subject to income tax. But if a person inherits a 401(k) or traditional IRA–say a father names his daughter as beneficiary–then income tax is due when the beneficiary makes withdrawals from the account. There is no income tax on an inherited Roth IRA, since tax was already paid when the original owner made contributions.

In many cases, a person will name their spouse as beneficiary of their retirement accounts. This allows the surviving spouse to “roll over” their deceased partner’s IRA or 401(k) into their own retirement account. This preserves the tax benefits until the surviving spouse must begin making withdrawals.

Do I Have to Leave My Retirement Account to My Spouse?

But what if you do not wish to name your spouse as beneficiary? In some cases that may not be possible. Federal law, which governs 401(k) plans and other employee-based retirement systems, automatically designates a surviving spouse as beneficiary. This can only be altered if the affected spouse signs a written waiver during the marriage.

In contrast, you are generally free to name anyone you choose as the beneficiary of an IRA. While the surviving spouse may benefit from the ability to roll over the account, there are many situations where it makes more sense to name another family member as beneficiary. An experienced Holland estate planning lawyer can answer any questions you may have about coordinating your retirement planning. Contact the Law Offices of David L. Carrier, P.C., if you would like to schedule an appointment today.