Friends and relatives other than spouses, children, and grandchildren aren’t usually given special consideration in estate planning matters. There may be people in your life you consider family but who may not be recognized legally as relatives. Each state has rules of succession laws which help determine who gets assets if there is no will or if the named beneficiaries aren’t sufficiently clear, but these rules don’t usually provide for individuals beyond the deceased’s immediate, legally recognized family.
You’ll still want to plan carefully to minimize estate tax on assets passing to these beneficiaries. You may also consider giving to these beneficiaries individually during your lifetime to take advantage of any annual gift tax exclusion and your lifetime gift tax exclusion. You can also contribute to their education or medical care without incurring any gift tax, by paying for these expenses directly.
Additionally, if paying for education is a concern for any of these beneficiaries, you may already have placed assets in a 529 Plan, Uniform Gifts to Minors Act (UGMA) account, or Uniform Transfers to Minors Act (UTMA) account. If not, doing so during your lifetime may be a strategic way to reduce the value of your taxable estate while working toward education savings goals.
If you have a 529 plan, you generally maintain control of the account until the money is withdrawn. Therefore, part of your estate planning might be to update the successor designation, which stipulates who will take over management of the account if you pass away.
And, as always, ensure your beneficiaries are up to date on other assets that have provisions for naming them, including investment and bank accounts with transfer on death (TOD) designations. This is especially important for beneficiaries outside your immediate family, as assets don’t usually go to such beneficiaries by default or outside of the probate process if they are not named properly.
Trusts can be especially beneficial for minor children, including nieces, nephews, and the children or grandchildren of close friends that you wish to designate as beneficiaries, as trusts provide the means for more control of the assets, even after your death. By setting up a trust, you can communicate how you want the money you leave to a minor beneficiary to be managed, the circumstances under which it can be distributed, and when it should be withheld. You can also determine if the child will be able to control the money at a certain age as either a co-trustee or the sole trustee.
A trust can also be an effective tool for transferring assets to adults, while potentially reducing estate taxes and allowing your influence on the assets even after you have passed away. A simple revocable trust or irrevocable trust may suit your needs, or you may require a more specialized trust depending on the asset or your circumstances.
Only spouses have the option of rolling retirement plan assets into their own IRAs; other beneficiaries will generally be required to begin taking minimum required distributions (MRDs) soon after your death based on their age—and to pay the associated income taxes. Additionally, your retirement plan assets will be included in the value of your estate for federal estate taxes with no corresponding deduction, potentially increasing your estate tax liability.
Although IRAs have no special provisions for naming non-spouse beneficiaries, you may name other individuals. You may also specify contingent beneficiaries, who will inherit the assets should a primary beneficiary pass away first.
As always, make sure your beneficiary designations are up to date; with missing or incorrect designations, your assets may not be distributed as you intend or your beneficiaries may have to wait to take ownership and incur costs due to probate and income taxes.
To learn about the options non-spouse beneficiaries will have when inheriting an IRA, see If you are a non-spouse IRA beneficiary in Fidelity Viewpoints®.
The rules for 401(k)s and other qualified retirement plans are similar to those for IRAs. If you are married and you want to designate beneficiaries other than your spouse, you may need written consent from your spouse.
Otherwise, such plans follow roughly the same guidelines for what is taxable, but other features will vary from plan to plan. Contact the plan’s administrator for specific rules governing your plan.