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Retirement Planning:
Beneficiary Designations

Dallas, Plano, and Allen, Texas Estate Planning

Qualified Retirement Plans account for approximately 35 percent of all household financial assets in the U.S., or nearly $16 trillion. Americans invest in these plans to provide for their own (and their spouses') retirement, to enjoy substantial tax savings and compounding interest, and to build family wealth for their heirs. The preferential tax treatment these assets receive, however, comes at a price that may be extracted at death. With proper planning, your IRA (or other qualified retirement funds) may be the best asset your children inherit. A few common mistakes, however, could make it the worst.

Planning with Appropriate Beneficiary Designations

There are two things you should never watch while they are being made: one is sausage and the other is tax law. The same can be said of most tax law changes. They often result in more complex do’s and don’ts, not to mention stiff penalties for non-compliance.

That said, the IRS has simplified its regulations governing distributions from IRAs and other qualified retirement plans (QRPs) in recent years. In form, these final regs are intended to liberalize and lengthen payout options during the lifetimes of plan participants and, after their deaths, for their designated beneficiaries. In substance, however, there are many common pitfalls to avoid regarding the designation of beneficiaries for your QRP lest your retirement assets plunge into the tax abyss, or wind up with the wrong beneficiary.

Unique Assets

QRPs are unique assets. Their fundamental purpose is to help plan participants send some of today’s dollars ahead for tomorrow’s retirement. To facilitate their fundamental purpose, QRPs enjoy preferential tax treatment during their creation and as they accumulate. They are created with pre-tax dollars and then grow tax-deferred. Consequently, through the tax-deferred annual compounding of their interest and dividends, QRPs often grow to produce rather impressive account balances. While they enjoy preferential tax treatment during their creation and accumulation stages, all distributions from QRPs are fully taxed as ordinary income (except when made to a charitable beneficiary).

Here is where plan participants and the IRS have competing goals. Plan participants want to delay distributions from their QRPs and enjoy the tax-deferred compounding as long as possible. The IRS, on the other hand, requires plan participants to take Required Minimum Distributions (RMDs) and to begin paying taxes on their distributions at ordinary income rates no later than April 1st of the year after which they turn age 70½ (and each year thereafter).

Upon the death of a plan participant, the final regs determine how quickly the remaining QRP must be paid out and taxed to the designated beneficiary(ies) based on a complex variety of factors. Here are two common pitfalls to avoid.

Failure to Designate

The failure to designate a beneficiary is the most common mistake people make regarding their QRPs.

Consequences:

1. If you die after you begin taking RMDs, then the balance of your QRP must be paid over your remaining life expectancy, using your account balance at the end of each year, your age at death (+ 1 thereafter) and the applicable divisor found in the Single Life Table (SLT) in IRS Publication 590; or
    
2. Even worse, if you die before you begin taking RMDs, then the balance of your QRP must be paid out within five years of your death.

One solution is to designate a loved one as the beneficiary. This will allow your QRP to be withdrawn in a more favorable manner than if you failed to designate a beneficiary at all. This simple move can save thousands of dollars in taxes.

Failure to Re-Designate

If you are divorced, and fail to re-designate a new beneficiary, your ex-spouse could inherit your QRP if it is provided by your employer under the Employee Retirement Income Security Act of 1974 (ERISA).

Consequence: If your QRP is governed by ERISA, and you fail to replace an ex-spouse, as beneficiary, they may inherit your QRP, even if your state’s laws automatically extinguish their interest in your estate.

When QRP assets are significant, it often is appropriate to explore more sophisticated solutions to protect funds from both unnecessary taxation and other predators: IRAs are an extremely attractive asset for beneficiaries' creditors, ex-spouses, and lawsuit plaintiffs.

Richard P. Johnson P.C. Attorneys at Law, of Plano, Texas, assist clients with Estate Planning, Wills, Trusts, Irrevocable Trusts, Revocable Living Trusts, Powers of Attorney, health care documents, Elder Law Planning, Long-Term Care Planning, Guardianships, Medicaid Crisis Planning, Asset Protection, Business Succession, Charitable Planning, Estate Tax Planning, Probate & Estate Administration, Special Needs Planning, Retirement planning, Veterans Benefits, and "Aid and Attendance Pension," in the cities of Dallas, Plano, and Allen, TX, and the surrounding areas, cities, and counties.  

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