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 properly designated 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 help reduce the burden, plan properly, utilize the deduction for federal estate taxes paid on these assets, and understand the required minimum distribution (RMD) rules.

Steps to help reduce 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 help reduce taxes on the retirement assets you pass on to your beneficiaries. Consult a tax advisor about your situation.

  • 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 RMD options from your accounts by your beneficiaries.
  • Inform your beneficiaries that 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 RMDs. The rules can be complicated. A tax advisor can help explain the requirements to you and your beneficiaries.

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

Although staying in plan may be desirable for your beneficiaries, 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.

Considerations if creditor protection is of concern

If creditor protection issues are a concern to you, the U.S. Supreme Court has opined that an inherited IRA is not eligible for bankruptcy protection (unless there is a separate state law providing such protection). This decision highlights the importance of beneficiary designations for each of your retirement accounts. For situations where creditor protection is of paramount concern and ERISA protection is not available, the use of trusts as beneficiaries may grow in popularity. Regardless, discussing this in advance with your attorney or tax advisor may help you to avoid any unintended consequences.

Next step

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