A 401(k) beneficiary is the person (or persons) who will receive the money in your retirement account upon your death. That sounds pretty simple, but there are several things about naming a beneficiary that you should know — especially if you’re married, divorced or considering naming your children as beneficiaries.
We’ll walk you through the ins and outs of picking a beneficiary, as well as what happens if you don’t.
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When you enroll in a 401(k) plan at work, you’ll often complete a form naming your beneficiaries. You’ll be asked to name at least two people: a primary beneficiary and a contingent (or secondary) beneficiary:
You may name more than one person in both the primary and contingent beneficiary categories. If you do, though, you’ll need to specify the percentage each primary beneficiary will receive. The shares don’t have to be equal, but the total must equal 100%. For example, you could name a sibling as a primary beneficiary receiving 80% of the account balance, and two charities receiving 10% each.
Selecting a 401(k) beneficiary might seem like a formality, but it’s incredibly important if you want to have a say in who inherits your account. If you’re married, your spouse is typically going to be the automatic beneficiary of your 401(k), even if you don’t officially name them on the beneficiary form; there may, however, be some exceptions depending on your plan. But if you’re single, or want someone other than your spouse to inherit your account, naming a beneficiary can prevent a lot of trouble for your heirs. Even if your spouse will be your automatic beneficiary, it may be a good idea to fill out the form for your records.
Typically, retirement accounts avoid the probate process and transfer directly to the named beneficiaries. Probate is a legal process in which the court determines whether a deceased person left a will and ensures the deceased person’s assets are distributed according to their will (or according to state law if the deceased person didn’t have a will).
If you don’t have any living 401(k) beneficiaries when you die, your 401(k) can wind up in probate, and several problems can arise:
If you’re married, 401(k) beneficiary rules typically consider your spouse as the default beneficiary of your account. Even if you want your spouse to inherit the account and the process will be automatic, your plan administrator might ask you to complete the beneficiary form just as a formality.
If you want to name someone other than your spouse as your beneficiary, your spouse will usually have to sign a spousal waiver agreeing to it. You can get a spousal waiver form from the firm that administers your employer’s 401(k) plan, and the waiver typically needs to be witnessed by a notary or a plan representative.
For example, say you’re married and you don’t want to name your spouse as a 401(k) beneficiary because they are already financially well off. Instead, you’d like to leave the account to your child from a previous relationship. Your spouse must agree to sign the waiver — if they don’t sign the waiver and you list your child as the sole beneficiary, your spouse will still inherit the account, regardless of what your beneficiary designation says.
If you’re not married, you can name anyone as your beneficiary without having to have extra documents signed. This could be your children, your parents, siblings, a friend or a favorite charity.
Just remember to update your beneficiary designation if your situation changes. For example, if you name your parents as beneficiaries and they die before you do, you’ll need to update your beneficiary designation to name someone else. If you get married later on, your spouse will likely automatically take precedence over anyone else named as a beneficiary. Thus, you’ll probably need to have them sign a spousal waiver if you want to keep your beneficiaries as is.
If you want to name a minor child as a beneficiary, you should consider consulting with an estate planning attorney first. Most 401(k) plans will not transfer money directly to a minor. Instead, a court will have to appoint a trustee or guardian to receive the funds, which can take some time.
There are a few ways to avoid this, and your options may depend on the laws in your state. Some states allow parents to name a minor as a beneficiary and a custodian who will manage the assets in the child’s best interest until they reach a certain age — usually 18 to 25, depending on the state.
Another option is to create a trust. When you create a trust, you also name a trustee who will manage trust assets on behalf of your child — either until they reach a certain age or for their lifetime. Then you would list your child’s trust as your beneficiary. In either case, it’s a good idea to consult with an attorney first to make sure you’re not unintentionally jeopardizing your child’s inheritance.
You should update your beneficiary designations any time you have a major life event, such as marriage, divorce, separation, a death in the family or the birth or adoption of a child. Of course, it can be difficult to remember to update paperwork amid major life events. For that reason, it’s a good idea to make reviewing your 401(k) beneficiaries something you do annually.
If you do need to update your beneficiary, it will likely take only a few minutes. Most plan custodians allow you to change your beneficiary online in just a few minutes, or print out the paperwork necessary to do so. If you can’t find instructions on your plan’s website, check with the benefits department at your workplace to get the beneficiary designation form and a spousal waiver (if needed).
Typically, inheritances aren’t taxable income as far as the IRS is concerned (although some states have an inheritance tax, and there is a federal estate tax for very large estates). But that’s not always the case with inherited 401(k) accounts.
If you have a traditional 401(k) (not a Roth account), then your account’s contributions have not yet been taxed. You funded the account with pre-tax income or employer contributions, and the earnings on those contributions have not been taxed either. As a result, when your beneficiary takes withdrawals from the account, those distributions are considered taxable income, and they will need to pay income tax.
Before Jan. 1, 2020, 401(k) heirs had the option of “stretching” payments — and thus the related tax bills — over their life expectancy. But the Setting Every Community Up for Retirement Enhancement (SECURE) Act changed that — now, beneficiaries have to withdraw assets from an inherited 401(k) within 10 years after the account holder’s death.
There are some exceptions:
If your beneficiary falls into one of these exception categories, they should talk to a financial advisor or tax professional before withdrawing any funds to ensure to take advantage of any potential tax planning or saving opportunities.
Naming a beneficiary for your 401(k) might seem like an inconsequential part of saving for retirement, but think carefully about who you want to inherit your account if you pass away unexpectedly — then be sure to update your beneficiary forms when things change.
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