Beneficiary Strategies
At GEM, we often work with several generations in managing families’ wealth. That work can vary, but at the moment we are helping to settle several estates. This process helps to reinforce the importance of estate planning and naming beneficiaries.
The Basics — Retirement account owners are able to name beneficiaries to receive the assets in the account upon their death. The beneficiary designation supersedes instructions of wills or trusts and avoids probate, allowing assets to directly transfer to the designated heirs.
Tip #1 — Did you know that depending on the state of residence, you can similarly name beneficiaries on non-retirement accounts through a transfer-on-death, or TOD designation? This designation allows you to keep control of an account during your lifetime but avoid the lengthy probate process.
Review — It’s a good idea to check any 401k, IRA, SEP or Roth account to ensure the correct beneficiaries are named. There are countless cases of accounts being opened in a rush without naming beneficiaries. Further, some older accounts may still designate ex-spouses or deceased individuals, or not include younger family members who weren’t yet born when the beneficiaries were first named.
The SECURE act of 2019 and the follow up SECURE 2.0 in 2022 made many changes to how retirement accounts work. Some of the main changes determine how these accounts are treated once they are inherited.
Tip #2 — If your estate plan has not been reviewed by an estate planning attorney since 2019, you should definitely arrange to have it checked. Certain designations used in the past may present problems for heirs under the new rules, especially if a trust is named as a beneficiary.
We suggest performing estate planning through an after-tax filter in an effort to preserve as much of an estate as possible for heirs. The recently passed, One Big Beautiful Bill Act, raised the estate exemption to $15 million for individuals and $30 million for married couples. But even heirs of estates under those amounts will have tax exposure from inherited retirement assets due to the SECURE Act’s 10-year rule.
10-Year Rule — Under the SECURE Act, most non-spouse beneficiaries must empty inherited retirement accounts within 10 years. These distributions are taxable as ordinary income. There are special rules for spouses, minor children, disabled or chronically ill individuals.
Estate Goals — We believe the overall goals of estate planning are two-fold. First, to distribute assets proportionally according to the owner’s intentions. Second, to distribute the assets in a way that best preserves them for the estate’s heirs on an after-tax basis.
Base Case — Many estate plans simply leave all the asset to the surviving spouse and then subsequently divided equally among their heirs on the death of the second spouse. Surviving spouses can stretch retirement income over their lifetime rather than 10-years, however, they will file income taxes as a single taxpayer with much higher tax brackets than previously.
Further, upon the second death, heirs will likely be subject to the 10-year rule, meaning the additional income could easily push them into higher tax brackets especially if they are still working.
Strategy #1 — Roth IRAs are subject to the 10-year rule, but the distributions are not taxed as income. Converting retirement assets to a Roth may be a good strategy if it is done under a lower tax rate than the beneficiaries would ultimately otherwise pay.
Strategy #2 — It may be a good strategy to leave some portion of the retirement assets to non-spouse beneficiaries if the remainder of the estate is sufficient to support the surviving spouse. The non-spouse beneficiaries would then distribute the inherited retirement funds over two separate 10-year periods, perhaps limiting the amounts taxed at the highest rates.
Strategy #3 — If the ultimate beneficiaries are in different tax brackets, it may be a good strategy to assign a relatively larger portion of the retirement assets to the lower earner. A larger portion of the Roth IRA assets or other assets that receive a step-up in cost basis upon death could be left to the higher earner, minimizing the aggregate amount of tax due on the proceeds of the estate.
Every situation is unique. At GEM Asset Management, we have helped clients utilize these and other strategies. Please reach out if you would like us to help evaluate your plan.