The beneficiary, the person or entity that receives the assets, can be either a person or a trust.
For example, while mom has left her entire estate to the children, concerns with one child has given mom pause due to concern about problems such as issues such as substance abuse or that the child’s creditors will take it all. So mom has decided that for one child, that share will be helped along or controlled by a third party called a trustee who is charged with using, controlling and investing for this child’s benefit that is spelled out in a trust within the will.
Importance of Having Named Beneficiaries
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Tax deferred accounts are special creatures. They allow us to, depending on what kind they are, for the most part, put pre-tax dollars into an account, allowing the account to accumulate income, and then when money comes out at certain ages or events, then the income is taxable, including the money that went into the account.
Because of this special treatment, when the money is pulled out the money is income taxable. Beneficiaries of this account also have the ability to pull the money out over a period of years. Why not pull it out all at once? Let’s say there is $1,000,000 that you accumulated over your life. If when you became eligible to pull it out you wrote a check to yourself and took 100% and put it into a checking account, the IRS would tax it all in one year at the highest tax rate because it is a large sum. Plus the IRS allows you to accumulate growth with no income tax if you don’t pull it out, including growth on any earning providing growth on growth on growth which would be lost if you put it into your personal account. If you don’t pull the money into your personal account you would be gaining money
Plus you would miss out on the IRS allowing you to accumulate growth with no income tax if you don’t pull it out, including growth on any earning providing growth on growth on growth which would be lost if you put it into your personal account. If you don’t pull the money into your personal account you would be gaining money tax-free.
The advantage of tax-deferred funds is that you accumulate wealth without an immediate tax bill. For most people that have accumulated wealth in retirement benefits, they don’t pull out money until they have to.
What Happens When Someone Inherits A Retirement Account?
A spouse has a special right to take a retirement account and roll it over into an account where they can hold off on drawing the money until they reach 70.5 years of age. Children must start drawing down money based on their life expectancy.
What if you forgot to name a beneficiary or one that pre-deceased you?
The problem is that the agreement to XYZ brokerage firm says that if there is a failure of a beneficiary, the fund’s go into your estate. The IRS will say 100% of the account is income taxable mostly in that year. It is critical that in beneficiary designations you are careful to not only name a primary beneficiary, but also a secondary beneficiary. It is important that beneficiaries consult with a lawyer to make sure that they are protected in the same way as the decedent. It is important that beneficiaries understand that when they roll-over accounts that they name beneficiaries and successor beneficiaries.
Other Assets That are Non-Probate
Joint accounts are also non-probate. This can include an account set up with mom and a child. Accounts with payable on death designations are non-probate. More and more people are having large accounts with mutual fund companies that promote having named beneficiaries on each of the accounts. These companies suggest having payable on death beneficiaries.
Why Care About Non-probate Assets?
Part of the estate administration process is taxes. There is a transfer tax that exists (called a death tax or estate tax) imposed just because assets are going from one person to another. Federally this tax can be imposed if whether the transfers happen during your lifetime or at death. In fact, the IRS keeps a running total of all transfers you make during your lifetime, resulting in your paying a tax when you pass. You can pay the tax along the way, but ultimately when you pass you need to pay those taxes.
How do You know the Rules?
Your lawyer on day 1 will tell you what you need to do. Nine months from the death, the Executor will file a Form 706, the Federal Estate Tax Return where you will report and list all of the assets including the probate and the non-probate assets. This includes all bank accounts, brokerage accounts, business accounts in the decedent’s name and assets such as retirement accounts and are included in the Estate Tax Return.
The state you live in might have inheritance taxes such as those in New York and New Jersey. In some states there are exemption amounts and if the estate is under the taxable amount you do not need to file a return. Federally each person in 2015 each person can pass $5.430 million dollars. If both husband and wife are citizens they can pass double that amount.
States like New Jersey have a low exemption amount and have rules based on the relationship between the giver and the givee.