It’s possible that you’ve spent decades dedicating time, attention and money to your retirement plan(s) – so it’s natural to wonder what might happen to anything that’s left when you pass away. Who will get the money? And how? What about taxes? Understanding these issues now can help reduce stress and worry in the future, both for you and your loved ones.
To begin, you can specify your beneficiaries. We generally recommend that you designate beneficiaries and their shares as well as any backup beneficiaries (a spouse may automatically have certain rights in claiming remaining retirement benefits).
If you don’t name a beneficiary (or the designated beneficiary passes away before you do and you don’t have a backup beneficiary), benefits will be distributed according to the terms of your retirement plan. Often, a plan will specify certain default beneficiaries, such as a spouse, or your retirement plan benefits may end up distributed to your estate. If this is the case, leftover benefits will be distributed according to the terms in your will. However, if you don’t have a will or if the benefits can’t be distributed under its terms, they will be distributed under your state’s intestate succession laws. For example, a typical intestate succession law might give one-half or one-third to your spouse with the balance divided equally among your children.
Estate taxes are another consideration – both for you and your beneficiaries. Several features of estate taxes are noteworthy:
Retirement plan benefits:
After you pass away, your retirement plan benefits will generally be included in your overall estate for federal estate-tax purposes.
Marital and charitable deductions:
There is an unlimited marital deduction for property you leave to your surviving spouse and an unlimited charitable deduction for property you leave to charity.
Avoiding estate taxes:
For 2017, the estate and gift tax exemption is $5.49 million per individual, which is up from $5.45 million in 2016 – so that means you can leave $5.49 million to beneficiaries without paying federal estate or gift tax. In addition, a married couple can give almost $11 million ($10.98 million) without being subjected to federal estate and gift taxes. Furthermore, you can give a gift tax-free as long as it’s worth less than $14,000. Also, note that the federal estate and gift tax exemptions rise with inflation – so the longer you live, the greater the exemption.1
Complications with couples:
It’s also important to be aware that estate tax rules for couples can be complex, particularly when it comes to what to do if your spouse passes without giving away their individual maximum amount and leaves the remainder to you. The surviving spouse must note this on the deceased spouse’s estate tax return (even if no other tax is due), which is a move called “portability.” If the surviving spouse doesn’t note portability on their deceased spouse’s estate tax return, he or she could be hit with an unexpected federal estate tax bill.1
Income taxes can also come into play for your beneficiaries. Here are some key facts to be aware of:
Retirement plan distributions:
After you pass away, your beneficiaries will generally be required to take distributions from your retirement plans over their life expectancies. The taxes on these distributions may be more favorable if your surviving spouse is the beneficiary of your retirement plan, as a surviving spouse is the only person allowed to roll over the retirement account into his or her IRA.
Generally, property that is included in your overall estate value is readjusted to be taxed at fair market value at the time you pass away. This step-up in basis is the readjustment of the value of an appreciated asset for tax purposes upon inheritance, determined to be the higher market value of the asset at the time of inheritance. When an asset is passed on to a beneficiary, its value is typically more than what it was when the original owner acquired it. The asset receives a step-up in basis so that the beneficiary’s capital gains tax is minimized.
In general, when your beneficiaries file income taxes each year, they’ll have to include any distributions from your retirement plan in their total income, but they can take an income tax deduction for them.
Estate planning can be complicated and sometimes seems even more complex when you think about how retirement plans factor into the process. By taking the time to research your options, however, you can better understand what will happen once you pass away – which ultimately can help bring you and your loved ones some peace of mind.
1 Ebeling, A. (25 Oct. 2016). IRS Announces 2017 Estate And Gift Tax Limits: The $11 Million Tax Break. Forbes. Retrieved March 10, 2017, from https://www.forbes.com/sites/ashleaebeling/2016/10/25/irs-announces-2017-estate-and-gift-tax-limits-the-11-million-tax-break/
Some information sourced from Broadridge Investor Communication Solutions, Inc.
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