Caution Required in Naming Beneficiaries on Tax-Deferred Retirement Accounts
March 27, 2019
Millions of Americans save for retirement by contributing pre-tax income into tax-deferred accounts such as IRAs, 401ks, TSAs and 403bs. Systematic contributions to a tax-deferred retirement account over a career can result in a substantial pre-tax balance at the time of retirement.
Eventually, money in tax-deferred retirement accounts must be withdrawn and taxed. Typically, a required minimum annual withdrawal begins when the account owner reaches age 70 1/2 and continues until death. If an account balance remains at the account owner’s death then that account balance passes to those persons and/or entities named as beneficiaries by the account owner. The potential then exists for those beneficiaries to continue a substantial portion of tax deferral over many more years, commonly called a “stretch out” of the taxable distributions.
Beneficiaries must be designated very carefully on tax-deferred accounts so that the stretch out of taxable distributions is not compromised. An improper or incomplete beneficiary selection can accelerate taxable distributions from the account thereby severely reducing the potential account value over the lifetime of the beneficiary.
The ability to stretch out taxable distributions over many years is only allowed for what the IRS calls “designated beneficiaries.” Most individuals satisfy the requirements to be considered “designated beneficiaries” but trusts and other entities may not satisfy the requirements.
Before naming a trust or entity such as a charity as a beneficiary on your tax-deferred retirement plan it is strongly advised that you meet with an estate planning attorney to review such a selection and to make sure you are not jeopardizing the tax-deferred benefits you worked so hard to achieve.
