Who Should Be the Beneficiary of Your 401(k) or IRA?

Posted on Jul 24, 2024 by

Deciding who to name as the beneficiary of your 401(k), IRA, or other qualified retirement account is a crucial part of estate planning. This decision can significantly impact how your assets are distributed and taxed after your death. With the introduction of the SECURE (Setting Every Community Up for Retirement Enhancement) Act on January 1, 2020, the rules governing these accounts have changed, making it even more important to understand your options.

One key choice is whether to name a trust or your children as beneficiaries. Each option comes with its own set of benefits and drawbacks. Here’s a quick summary to help you make an informed decision:

Naming a Trust as the Beneficiary
One primary reason for naming a trust as the beneficiary is to exert control over how the assets are distributed after your passing. This can be particularly useful if you have minor children or beneficiaries with special needs, as it allows you to specify the terms under which distributions are made.

Generally, we recommend listing your trust as the beneficiary of a qualified account when you have a disabled or black-sheep beneficiary, or if you have a taxable estate.

The SECURE Act introduced significant changes to how inherited retirement accounts are handled, particularly for non-spouse beneficiaries. Under the SECURE Act, most non-spouse beneficiaries, including trusts, must now distribute the inherited retirement account within ten years of the original owner’s death. To qualify for this ten-year treatment, trusts need to contain specific language. If your trust has not been reviewed since the law went into effect on January 1, 2020, we recommend having someone review its provisions to ensure they comply.

Naming Children as Beneficiaries
Naming your children directly as beneficiaries can simplify the distribution process. They would have more flexibility in managing the inherited retirement account and do not have to worry about whether the specific language of your trust complies with the SECURE Act rules.

Under the SECURE Act, if your children are designated as beneficiaries, they still must withdraw the funds within ten years. However, this could still allow for more tax-efficient planning, as they could potentially spread out distributions strategically to minimize tax impact over the ten-year period.

There are some potential risks with directly naming children as beneficiaries. First, it means they have immediate access to the funds upon your passing. Depending on their financial maturity and responsibility, this could pose a risk of mismanagement or rapid depletion of the retirement savings. Additionally, if a beneficiary is disabled, leaving an IRA directly to the beneficiary will likely disqualify them from any government benefits programs they were previously enrolled in.

Both options have their pros and cons, and the best choice depends on your specific circumstances, goals, and family dynamics. It’s advisable to consult with a qualified estate planning attorney who can assess your situation and help you make an informed decision considering all relevant factors, including the SECURE Act implications.

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Jon L. Fischer

Estate Planning and Elder Law Attorney at McCarty Law LLP
Jon focuses his practice on estate planning, probate matters, and Medicaid planning as he aims to help clients in their time of need.