Date: May 15, 2017
Magazine:
May/June 2017

By Matt Lewis

In my experience as a financial professional, one seemingly simple task often creates significant unintended consequences for individuals with retirement and other investment accounts: the proper designation of beneficiaries.

First, a bit of terminology. In a qualified account, such as a 401(k) or traditional IRA, the contributions are pre-tax and grow tax-deferred until withdrawal. Non-qualified accounts include investments that are made after-tax, and include personal assets of real estate, life and annuity insurance policies, in addition to stocks, bonds and other traditional investments not bought under qualified plans.

Why is this investment lesson so important? Because the type of account you have—qualified vs. non-qualified—will generally determine who you should designate as your beneficiaries.

Let me illustrate this with an example. Recently, one of my clients was the administrator for his deceased brother’s estate. The deceased brother in this story, who was divorced with three adult children, made his trust, not his three adult children, the beneficiary of his traditional IRA (if we recall from our earlier brief lesson, a qualified account).

Naming his trust as the beneficiary of his qualified retirement account may have seemed like a logical designation, especially since his trust documentation clearly left the beneficiaries of his estate to his children. However, by choosing to designate the trust as the beneficiary of his traditional IRA, the brother created a taxable event that could not be rectified and resulted in the payment of tens of thousands of dollars in taxes up front prior to equally distributing the remaining amount.

As this case demonstrates, when a single, unmarried person has qualified assets that are tax-deferred, an individual should (more often than not) be designated as the beneficiary. Had the deceased brother listed his three adult children as the beneficiaries, they would have been able to transfer the inherited money into an “inherited” IRA, which would have allowed them to only take smaller required minimum distributions, lessening the taxation burden and stretching it out over the course of several years.

To be sure, there are some exceptions, such as when children are of minor age or have special needs, where a trust can be helpful solution for qualified retirement accounts.

For non-qualified personal assets such as real estate, life and annuity insurance policies and other tangible personal property, these investments should be clearly defined in a trust or in a will that specifies who will be the beneficiaries of such assets. Under the current estate tax exemption for 2017, the IRS allows for $5.49 million dollars of personal property to pass tax-free, regardless of who inherits the assets. This amount is indexed for inflation in future years so it is expected to go up over time.

In light of this example, it may make some sense to look at your current qualified investment accounts, such as your 401(k) and/or traditional IRA, to determine if you have the proper primary and contingent beneficiaries listed on your paperwork. It is especially important to revisit your designated beneficiaries if you have had any recent life changes, such as a divorce or loss of a loved one.

Western Growers Financial Services (WGFS) is a full-service investment brokerage company that specializes in individual and company retirement accounts, as well as wealth management strategies. We are available to provide our members guidance on proper beneficiary designations, and can also recommend reputable outside experts to assist you in your taxation and estate planning. For additional information or consultation, contact WGFS President Matt Lewis (949.885.2379 or mlewis@wga.com).

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