Retirement assets like 401(k) accounts and IRAs make up more than one in every three dollars of U.S. investments — and for middle and upper-middle class households they’re often the largest asset outside the family home. Transferring these tax-deferred assets to heirs can be tricky, though. To help advisors and their clients make the most of these assets, we identified seven frequent and costly mistakes that they can make when performing estate planning for retirement assets and how to avoid them, including:
Mistake #1: Not naming beneficiaries
Retirement assets are transferred outside the normal estate planning process to “designated beneficiaries” named on each individual account. Clients who don’t name beneficiaries can lose much of the planning flexibility around these accounts, so it’s important to make sure each separate IRA, 401(k), 403(b) or 457 account has a designated beneficiary.
Mistake #2: Not reviewing beneficiaries regularly
Clients often forget to update beneficiaries on old retirement accounts, which can mean that their choices are outdated. Designated beneficiaries may have passed away. Children and grandchildren may not have been born when the accounts are opened. Reviewing these designations regularly can ensure that assets are distributed according to the owner’s wishes.
Mistake #3: Losing the stretch
Younger family members with long lives ahead of them can “stretch” mandatory withdrawals over many decades, preserving tax deferral and increasing the ultimate value of the account. Choosing an older beneficiary, even as a contingent beneficiary, can reduce the stretch significantly and expose heirs to higher income taxes as assets must be withdrawn in larger amounts
Mistake #4: Failing to use trusts to protect assets
Just by designating a beneficiary, your clients ensure the orderly transfer of retirement assets; however additional protections and controls are available when these assets are transferred via trusts. Placing assets in trust can protect them against creditors, divorced spouses and even the beneficiary himself if the account owner wants to place “spendthrift” restrictions on use of inherited assets. However, it’s tricky to preserve tax deferral when assets are placed in trust, as we discuss in #5 .
Mistake #5: Not qualifying as designated beneficiary trust
Trusts offer very useful protection against third-party claims, but when carelessly structured, they can shorten the withdrawal period dramatically – to just five years. Fortunately, estate planners can get around this problem, while still providing protections against creditors, by structuring a “designated beneficiary trust,” or “look-through trust.”
Mistake #6: Naming the wrong contingent beneficiaries
Even when clients have successfully created a designated beneficiary trust, some hurdles remain. As stated earlier, the required minimum withdrawal schedule is determined by the oldest beneficiary. The problem comes when a trust has contingent beneficiaries, especially contingent beneficiaries who are older than the primary ones. For example, say a woman leaves her IRA to her children, and if they die before she does, her grandchildren, and if all of them die and there are no grandchildren, her brother. The brother’s life expectancy, almost surely the shortest of the bunch, will determine how fast the assets must be withdrawn, even though he is unlikely to ever inherit the assets. Financial advisors and estate attorneys can help their clients by reviewing beneficiaries and contingent beneficiaries carefully and highlighting any potential problems.
Mistake #7: Not coordinating financial planning and estate planning
It’s critical for financial planners and investment advisors to work closely with their clients’ estate planning experts, because they’re able to spot problems early, while there is still time to fix them.
Adding value through expertise
Retirement assets are a big slice of the historic generational asset transfer now in motion, and because of their complex tax and legal structure, your clients need help in maximizing the value of this part of their legacy. For more information on avoiding these seven deadly mistakes, download Premier Trust’s white paper “Inheriting the 401(k).”
