Tag Archives: retirement accounts



For many of us, individual retirement accounts can be one of our major assets.   They include 401(ks), Roth 401(k)s, 403(b)s, Individual Retirement Accounts (IRAs),  Roth IRAs, Keoughs and SEPS.

We spend a lot of time deciding what to invest in and how to make our 401(ks) and IRAs grow while we are living.  Few of us understand the rules and complexities associated with our choice of beneficiaries and their choices when we die.   Rules that are created by the Internal Revenue Service and the custodian of the retirement account.  Rules and choices that have a huge impact on the long term value of a tax deferred retirement account.

If your beneficiaries don’t follow these rules when they establish inherited IRAs, they can lost their ability to stretch the tax deferred benefits available through an inherited retirement account.

The following questions and answers discuss 401(k) and individual retirement accounts (IRAs) retirement laws and the how the choices you and your beneficiaries make impact the tax deferred value of your retirement accounts.

The rules and laws regarding retirement accounts are complex.  We recommend you, or your beneficiaries, visit someone with specialized knowledge about inherited retirement accounts before finalizing your beneficiary choices.

Federal Laws

Q.  What does the Internal Revenue Service (IRS) have to do with inherited retirement accounts?

A.  Your retirement accounts are your self funded pension.  Congress wrote a set of rules which created the ability to set up retirement accounts.  The Internal Revenue Service creates and documents the guidelines on how and when to contribute or withdraw distributions that meets the laws passed by Congress.  m

The rules and regulations your beneficiaries must follow for inherited retirement accounts are not managed by your will or living trust.   They are governed by a series of complex IRS rules dictating the manner and degree to which beneficiaries access the retirement accounts they inherit.  Yes, the same IRS which oversees you federal income tax returns.

Think of these retirement account laws as creating a special will directing what happens to your retirement accounts.  A will you didn’t write.  A will managed by IRS guidelines and new rulings from the IRS on what the guidelines really mean.

Custodian Agreement

Q.  How does your custodian agreement impact what happens with your retirement accounts?

A.  When you open a retirement account, you sign a contract with the custodian.  Your retirement account is then managed according to the terms of the agreement between you and your custodian.  If you are employed and contributing to a 401(k), the custodian is usually your employer.  If you have a self directed IRA account at Charles Schwab, Charles Schwab is the custodian.

Although the IRS provides guidelines on how a retirement account should operate, the custodian agreements may be different from one custodian to another.  You should read the custodian agreement very carefully.

  • You may find the agreement includes language designating a default beneficiary, otherwise known as a “contingent beneficiary”, who inherits your retirement account if (a) your designated beneficiaries die before you, (b) you have designated your estate as the beneficiary, or (c) your designated beneficiaries die at the same time you do.
  • The agreement may also include default language regarding whether your beneficiaries inherit on a per stirpes or per capita basis.  You may find the default provisions don’t match your own beneficiary preferences
  • Although new laws permit non-spouse beneficiaries or 401(k) accounts to set up inherited IRAs, not all 401(k) custodian agreements offer this option.



Q.   What is a pre-tax retirement plan?

A.  401(ks)sm 403(b)s , Keoughs, and Individual Retirement Accounts (IRAs) are funded with pre-tax contributions.    For example:

  • You earn $10,000 in 2008 and you contribute $1,000 to your retirement account
  • You deduct the $1,000 of retirement contributions from your taxable income
  • You report taxable income of $9,000 on your Form 1040 tax return and you pay income taxes on $9,000.
  • The $1,000 is considered a pre-tax retirement contribution, as you did not pay taxes on the $1,000 contribution you made to your retirement account.
  • You will be required to start taking required minimum distributions at the age of 70 1/2.    Withdrawals will be reported on your 1040 tax return and you will pay applicable taxes.

Q.   What is a post-tax retirement plan?

A.  Roth IRAs, Roth 401(k)s and Roth 403(b) retirement accounts are funded with post-tax contributions.

  • You earn $10,000 in 2008 and you contribute $1,00 to your retirement account.
  • You report taxable income of $10,000 on your Form 1040 tax return and pay income tax on the entire $10,000
  • The $1,000 is considered a post-tax retirement contribution, as you paid taxes on $1,000 of income.  Your retirement contributions were made with money you have left after paying any federal and state income taxes due.
  • You, as the original owner are not subject to any required minimum distributions.   In fact, the earnings in a post-tax retirement plan may grow tax deferred until you die.


Q. Can you decide when your beneficiaries withdraw the funds they inherit?

A. Unless you set up a trust for managing your retirement accounts, your beneficiaries are in control of when they withdraw their funds.

  • A beneficiary can immediately withdraw the entire balance of your retirement accounts and pay any taxes due.
  • A beneficiary can withdraw the entire amount over a 5 year period and pay any taxes due.
  • A beneficiary can set up an inherited IRA account and stretch the tax deferred nature of your account, maximizing the value of the retirement account for your beneficaries
  • A surviving souse beneficiary can roll over the account into or his her own.


Q. Are you required to name your spouse as the beneficiary of your retirement account?

A. Federal regulations automatically designate your spouse as the beneficiary of your 401(k) or Roth 401(k) retirement account.  You may not designate another person as the primary beneficiary unless your spouse signs a document approving such a designation.   In some states, the document signed by your wife must be notarized.

If you live in a community property state, you will also need written spousal consent if you, as the owner of a self directed IRA or Roth IRA, want to designate someone other than your spouse as your primary beneficiary.  In some community states, the document signed by your spouse must be notarized.

Fact.  These community states require the consent to be notarized:  Alaska, Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.

Q.  If you list your spouse as your designated beneficiary, can the surviving spouse roll over your account into an account of their own?

A.  If your spouse is the only person you name as a beneficiary, your surviving spouse has the right to roll over your retirement account into theirs.   Onc the roll over is complete, the surviving spouse is listed as the owner of the account.  The surviving spouse inherits the same rights as the original owner of the account.

  • The surviving spouse can name a designated beneficiary who will inherit the account when the surviving spouse dies.
  • The surviving spouse can continue making contributions to the account.
  • The assets continue to grow tax deferred.
  • A 10% penalty is assessed if the surviving spouse withdraws money before the age of 59 1/2.
  • A spouse who inherits an IRA or 401(k) must start taking required distributions (RMD) at the age of 70 1/2 using the IRS Publication 590, Table II life expectancy factor.
  • If the account owner who died was taking RMD, the surviving spouse can withdraw funds necessary to pay the required RMD of the deceased without incurring a 10% penalty.
  • A spouse who inherits a Roth account can decide when they want to start taking withdrawals.

If a surviving spouse is not the sole beneficiary, the surviving spouse and the other named beneficiaries must set up inherited accounts or withdraw all of the funds within 5 years.

Q. Can a surviving spouse elect to stay a beneficiary?

A. Yes   A surviving spouse has the right to stay a beneficiary rather than rolling over an inherited retirement account into theirs.  If they elect to do this, they must set up an inherited account and will have the same rights as all beneficiaries of an inherited retirement account.

The downside of an inherited IRA versus a rollover is the surviving spouse beneficiaries are treated as successor beneficiaries.  Their life expectancy factor is inherited from the life expectancy factor of the surviving spouse, reducing the ability of a young beneficiary to stretch the payout over a long period of time.


Q. What if someone other than your spouse is the named beneficiary?

A. A beneficiary can elect to immediately withdraw all of the money, or the beneficiary can elect to set up an inherited retirement account.


Q. What is an inherited retirement account?

A.  An inherited retirement account allows your spouse and any other designated beneficiary to maintain the tax deferred nature of your account.   The length of time the funds can continue to grow tax deferred depends upon the beneficiary’s age when he or she inherited the account.  Some people refer to this as “stretching” the retirement account.

Although the original owner of a Roth IRA is not subject to required minimum distribution calculations, their beneficiaries are.

Q. Can a beneficiary of a company sponsored retirement account set up an inherited retirement account?

A. The rules are different for company sponsored retirement plands and self directed IRAs and Roth accounts.

Until the Pension Reform Act of 2006 was passed, non-spouse beneficiaries o were not allowed to set up inherited IRAs.  Beneficiaries had to comply with the company plan rules, which usually required an immediate distribution of the retirement funds, or allowed the funds to be distributed in a one or two year window.

Under the new Pension Reform Act rules, a non-spouse beneficiary can now roll over the funds into an inherited account.  This right is not a mandatory requirement.  The custodian agreement governing the 401(k) plan you are part of must offer this feature.

Q. What should you know about inherited retirement accounts?

A. The rules for inherited retirements accounts are the same, no matter whether the original account was a 401(k)/IRA or a Roth 401(k)/Roth IRA plan.

  • The name of the original retirement account owner continues to be listed as the owner on the inherited account paperwork.
  • The social security number of the beneficiary inheriting the account is added to the account records.   All distributions will be reported to the IRS using the beneficiary’s SSN.
  • A beneficiary of an inherited account cannot make further contributions to the account.
  • There is no 10% penalty for taking distributions before the age of 59 1/2.
  • If there are multiple beneficiaries, a separate account must be established for each beneficiary by December 31 of the calendar year following your year of death.

Q.  What happens if your designated beneficiary dies before all of the inherited retirement funds are distributed?

A. When the designated beneficiary set up the inherited retirement account, IRS regulations allow the designated beneficiary to name a successor beneficiary,.

  • If the beneficiary dies and funds are still available for distribution, a named living successor beneficiary can continue to take advantage of the stretch payout available to the original designated beneficiary.  The successor beneficiary also inherits the life expectancy factor of the original beneficiary and uses this to calculate their RMDs.
  • The successor beneficiary has the same rights as the original beneficiary.  They can name a successor beneficiary who will inherit the account and the remaining RMD of the original beneficiary.

Q. Will your beneficiaries need to pay income tax on their withdrawals?

A. The beneficiary of an inherited retirement account assumes the same income tax rules as the original account owner.

The beneficiaries of a post-tax inherited retirement account, Roth IRAs and Roth 401(k)s, receive their distributions tax free.

The beneficiaries of a pre-tax inherited retirement account, 401(k)s and IRAs report their distributions as income and pay the applicable federal and state income tax.

Q. What happens if your estate is listed as the beneficiary or the estate becomes the default beneficiary?

A. Naming your estate as the beneficiary of our IRA, or having the estate become the beneficiary because there is no living named beneficiary, has a variety of consequences.

When the beneficiary is the estate, the retirement account becomes a probate asset and is subject to the same delays, costs and processes as other assets that are being probated.

Most custodial accounts provide that if an owner dies without naming a beneficiary, the account beneficiary is the owner’s estate.  In such a case, the account beneficiaries will be the heirs of your estate determined by your will or, if you don’t have a will, state intestate statues.  However, some IRA custodial agreements contain language defining the beneficiary if the estate is the named or default beneficiary.

If the estate is the beneficiary, the beneficiaries lose their right to set up inherited accounts.  They must either withdraw all of the funds within five years or use the life expectancy factor of the original owner of the retirement account.

Q. What happens if you name a minor child as a beneficiary?

A. Minor children cannot manage money or other property until they are legally an adult, which happens when they turn 18 or 21, depending on state laws.  See the section on Minor Children for help on giving property to a minor child.


Q. Why would you establish a trust as the beneficiary of your retirement account?

A.  Naming an IRA trust as the beneficiary of your retirement accounts provides you with several options not available if you name an individual or your spouse as the designated beneficiary:

  • You can control when a beneficiary can withdraw the funds.  If you want to maximize the value of a stretched retirement account, consider setting up an IRA trust.
  • If the beneficiary is a minor child, the trustee can name a trustee who will manage the money on behalf of the minor child without any involvement of the probate court
  • You may want to control the second inheritance of the account.   If you are in a second marriage, you may want to give your spouse distributions from an inherited retirement account while he or she is living, but control who inherits the accounts when he or she dies.  In contrast, if you name your spouse as the primary beneficiary, the spouse will also inherit the right to determine who receives the inherited account when he or she dies.

Be sure and consult an attorney with knowledge in this area.  The IRA trust needs special language identifying the beneficiaries.  If the IRS does not believe the trust meets its requirements for naming beneficiaries, the trustee must take a lump sum distribution of the assets or pay out all of the funds within a five year period.

Naming a trust as the beneficiary is not the same as transferring your retirement account into the name of the trust.  DO NOT TRANSFER THE TITLE ON YOUR RETIREMENT ACCOUNT INTO A TRUST WHILE YOU ARE LIVING.   Such action may cause the account to lose its tax-deferred status and you would need to report the transfer as income and pay any necessary taxes.


Q. Is your retirement account part of your taxable estate?

A. Your retirement accounts are part of your federal taxable estate.   If your estate is subject to the estate tax, understand how these taxes will be paid.   Discuss the opportunities to use the funds in your retirement accounts to fund life insurance or annuities to offset the costs of estate taxes.

Wherever possible, try to save the funds in the retirement accounts from being used to pay estate taxes.  Talk with your beneficiaries before you die.  Understand how your estate will pay estate taxes and keep the tax tax deferred advantage of your retirement accounts for your heir.


Plan For Death

"Just a little bit of planning made my live so much better."

“Just a little bit of planning made my life so much better.”


Dying is not just an emotional event in our life, it is a major financial event as well.  Consider the following possible financial consequences of your death:

  • The paperwork and legal procedures required to settle your estate can cost your family four to eight percent of your net worth.
  • If probate is required, your family’s inheritance can be delayed for months, and in some cases, several years.  During the probate process, the courts decide when your family can sell your personal residence.  Even though your children can’t afford to pay the mortgage.
  • Contract law may override the instructions in your Will or Living Trust
  • Giving your share of your estate directly to your spouse may cost your family hundreds of thousands of dollars.
  • If you or your surviving spouse die without a will, most state intestate laws do not provide for stepchildren.
  • Naming a minor child as a beneficiary can subject the supervision of their money to the probate court.  For a fee.
  • Giving money directly to a minor child with special needs can make the child ineligible for government benefits.
  • Your business may go out of business because no one know how to access digital records.
  • The beneficiary choice of per capita or per stirpes may accidentally disinherit a grandchild
  • Your choice of a beneficiary for your 401(k) or IRA retirement accounts can dramatically change the after death tax deferred value of these accounts.
  • If you don’t have long term care insurance, you must use your assets to pay for long term care.  There may be no assets when you die.
  • Life insurance proceeds may be part of your taxable estate.  If your estate is subject to the federal estate tax, almost half of the life insurance proceeds may be needed to pay the estate tax on the insurance proceeds.


When someone dies, a series of laws and rules determine who has the legal authority to manage the decedent’s financial affairs.

These rules and documents also determine your beneficiaries and the cost, time and effort it will take to settle your estate when you die.  Planning now will save your family money later.

These resources are useful when making plans to keep your money when you die: