Are You Leaving A Tax Surprise for Your Beneficiaries?

If you’re like many Americans, much of your retirement assets may exist in plans such as an employer-sponsored 401(k) or an IRA. These plans are attractive retirement savings vehicles because of their unique tax structure. Many qualified plans offer tax-deductible contributions and tax-deferred growth as long as the funds stay in the account. On most qualified plans, though, the taxes aren’t deferred forever. While the Roth IRA offers tax-free distributions, withdrawals from 401(k) plans, traditional IRAs and other IRA types are considered taxable events. Your beneficiaries aren’t exempt from qualified-plan tax rules. If you pass away and leave a qualified plan to your loved ones, they could face a wide range of taxes and fees. Fortunately, there are steps you can take to protect them from this risk. Below are a few possible fees they could face, along with planning steps:

RMD Excise Taxes

With the exception of the Roth IRA, most qualified plans require you to start taking distributions at age 70½. The reason for this rule is simple. The funds have been growing tax-deferred for years, but you can’t avoid taxes forever. The IRS has set 70½ as the age at which distributions and taxes must begin. If you fail to take required minimum distributions (RMDs) as scheduled, you will likely face an excise tax of 50 percent of the distribution amount. What happens if you fail to pay that tax? After you pass away, the tax may be levied on your estate, reducing the amount of assets passed on to your heirs. Your loved ones could apply for a waiver of the excise tax, but there’s no guarantee it would be approved. The good news is that this is a simple risk to avoid. Take your RMDs as scheduled and pay any excise taxes that may arise, and you’ll protect your loved ones from this financial threat.

Probate Costs

Qualified plans are beneficiary-designated accounts. That means you name one or more beneficiaries on each IRA, 401(k) plan or other qualified account. When you pass away, your beneficiaries simply fill out a death claim form and receive their share of the benefit. The asset bypasses probate, which can be a costly and time-consuming process. If you fail to name a beneficiary, however, or if your beneficiaries predecease you, the benefit could be paid to your estate. In that case, the assets would go through probate and could be vulnerable to substantial administrative and legal fees and delays. Review your beneficiaries regularly to make sure they’re current.

Income Taxes

Just as you will face income tax obligations on your qualified account distributions, so too will your beneficiaries. Their death benefit payout from your traditional IRA, 401(k) and other plans is taxable income. If the benefit is sizable, it could push them into a higher tax bracket. Fortunately, they have options. If your beneficiary is your spouse, they may be able to roll your plan into theirs, avoiding tax liability. Nonspouse beneficiaries may have the option of spreading payments out over several years or even their lifetime, thus also spreading out the tax payments. Talk with your beneficiaries in advance about their options so they can plan ahead. You may even want to bring them to a meeting with your financial professional so they’ll fully understand their options. Ready to address qualified-plan risks for your beneficiaries? Let’s talk about it. Contact us at WMS Group. We can help you analyze your needs and goals and develop a strategy. Let’s connect soon and start the conversation.