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Retirement Accounts

Planning is even more crucial due to the special rules associated with retirement accounts, such as IRAs and 401(k)s.

Retirement assets generally transfer directly to beneficiaries without passing through probate. However, the downside is that these assets are often subject to federal and state income tax, as well as possible federal and state estate tax. To reduce the burden, plan properly, utilize the deduction for federal estate taxes paid on these assets, and understand the minimum required distribution (MRD) rules.

Steps to help minimize taxes

Do retirement accounts pass through probate?

NO, as long as the beneficiaries are properly designated. Keep in mind that if the will stipulates anything about such accounts, the named beneficiaries take precedence over the will and the assets will be distributed to the named beneficiaries on the accounts.

YES, if there are no beneficiaries named on the account and if the plan documents or any associated IRA custodial agreements do not specifically address who would then be the beneficiary. For example, generally if all of the named beneficiaries have passed away first and the designation was never updated, the account will be subject to probate.

There are several things you can do in the estate planning process that may reduce taxes on the retirement assets you pass on to your beneficiaries.

  • Designate your beneficiaries carefully and review your designations before you’re required to begin taking distributions from your retirement plan accounts. Your choices may impact the MRD options from your accounts by your beneficiaries.
  • Let your beneficiaries know they may be able to take an income tax deduction for federal estate tax paid with respect to the retirement account; this can substantially reduce the income tax they will owe when they withdraw the assets.
  • Consider an irrevocable life insurance trust (ILIT) to provide liquidity to pay the federal estate tax related to your retirement assets. This can help avoid leaving your beneficiaries in a position where they have to accelerate distributions to cover estate taxes.
  • If you plan to leave some of your estate to charity, consider designating retirement plan assets for this purpose. These assets may escape both estate and income tax. Consider placing these assets in a separate retirement account to preserve payout options for your other retirement account beneficiaries.
  • Make your beneficiaries aware that they will need to take MRDs. Note that beneficiaries may be able to stretch IRA distributions over their life expectancy, helping to minimize income taxes. The rules can be complicated, so you should consult your tax advisor.

There are also special provisions for surviving spouses in most retirement plans.

To learn about the options your beneficiaries will have when inheriting an IRA, see Fidelity Viewpoints® on Inherited IRAs.

401(k)s and other defined-contribution plans

The rules for transfer of accounts held in 401(k)s and other defined-contribution plans are similar to those for IRAs, including special provisions for spouses. They follow roughly the same guidelines for what is taxable, but other features will vary from plan to plan. It’s a good idea to contact the plan’s administrator for specific rules governing your plan.

Next step

Reviewing & updating your estate plan
Keeping your estate plan up to date is just as important as creating it.

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minimum required distribution (MRD)

mandatory, minimum yearly withdrawals that generally must be taken starting in the year the accountholder turns 70½, upon retirement, or at death

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irrevocable life insurance trust (ILIT)

irrevocable trust funded with a life insurance policy and designed to exclude life insurance proceeds from the taxable estate while providing liquidity to the estate and/or the trust's beneficiaries; it generally cannot be changed once it is created

Questions?

The tax information and estate planning information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice. Fidelity does not provide legal or tax advice. Fidelity cannot guarantee that such information is accurate, complete, or timely. Laws of a particular state or laws which may be applicable to a particular situation may have an impact on the applicability, accuracy, or completeness of such information. Federal and state laws and regulations are complex and are subject to change. Changes in such laws and regulations may have a material impact on pre- and/or after-tax investment results. Fidelity makes no warranties with regard to such information or results obtained by its use. Fidelity disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Always consult an attorney or tax professional regarding your specific legal or tax situation.

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