This week, we’ll explore how the law affects retirement distributions for married couples, and why you’ll need to be extra careful with your retirement accounts if you’re in a blended family. It’s extremely important to be aware of the changes in the tax code to maximize your retirement funds and ensure that you’ve set up your beneficiary designations correctly, so your retirement accounts go to the people you want and you take advantage of the tax benefits only afforded to certain family members.
If you’re part of a blended family (meaning you are married and have children from a prior relationship), you’re no stranger to the extra considerations and planning it takes to keep your family’s life running smoothly – from which parent your children will be with for the holidays to figuring out the schedule for a much-needed family vacation. You’ve also probably given some thought to (or worried about) what you want to happen to your assets and your family if something happens to you.
But what you might not have realized is: If you don’t create a plan for your assets before you die, the law has its own plan for you that might not reflect your wishes for your assets, especially your retirement assets. And if you’re in a blended family, this can have a significant financial impact on the ones you love and even create conflict that could lead to a long and expensive legal battle.
How ERISA Affects 401K Distributions
If you’ve remarried, you and your new spouse may have talked about updating the beneficiary designations on your retirement accounts to reflect your blended family arrangement. If you haven’t, you need to ASAP and you should probably go look at who is named right away. All too often, we have seen an ex-spouse inadvertently still listed as a beneficiary of their accounts and this oversight can lead to a major problem if something happens to you before it’s corrected.
Something else we often see is that people who are remarried decide to leave their retirement funds to their children from a prior marriage and leave other assets like their house and savings accounts to their current spouse. You may do this to avoid future conflict between your spouse and your children over your assets.
First – you need to know that even if you want to leave your retirement account just to your children, if you’re married and your retirement account is a work-sponsored account, your children won’t inherit the entire account even if you name them as the sole beneficiaries. That’s because the federal Employee Retirement Income Security Act (ERISA) governs most employer-sponsored pensions and retirement accounts. Under ERISA, if you’re married at the time of your death, your spouse is automatically entitled to receive 50 percent of the value of your employer-sponsored plan – even if your beneficiary designations say otherwise.
The only time that your surviving spouse would not inherit half of your ERISA-governed retirement account is if your spouse signs an official Spousal Waiver saying they are affirmatively waiving their right to inherit 50 percent of the account, or if the account beneficiary is a Trust of which your spouse is a primary beneficiary.
Second – you need to know that you are leaving some significant tax benefits on the table. Under the SECURE Act, which we have discussed in great detail in past articles, your children will be required to liquidate your retirement account and pay taxes on all those funds within ten (10) years. They will most likely be doing this during the period of their highest earning potential, and in turn, paying an even greater amount of taxes on those funds. On the other hand, your spouse is afforded the right to rollover your retirement account as if it was their own, or continue taking Required Minimum Distributions (RMD’s), as if they were you. Meaning they won’t have to take out the entirety of your retirement account within ten (10) years.
IRAs Have Different Rules Than 401(K)’s
If you want your children to inherit more than 50 percent of your work-sponsored retirement benefits, and completing a Spousal Waiver isn’t an option, consider rolling the account into a personal IRA instead.
In contrast to 401(k)’s and similar employer-sponsored plans, IRAs are controlled by state law instead of ERISA. That means that your spouse is not automatically entitled to any part of your IRA.
When you roll a 401(k) into an IRA, you gain the flexibility to name anyone you choose as the designated beneficiary, with or without your spouse’s consent.
On the other hand, if you want to ensure your spouse receives half of your retirement savings, make sure to include them as a 50 percent beneficiary, or better yet, have your individual retirement account payout to a Trust instead. Now, if you are going to with this strategy, it is extremely important to consult with a professional on exactly how you need to identify them as beneficiaries, so you do not inadvertently disqualify them from qualifying as an eligible designated beneficiary under the SECURE Act, but with a Trust overseeing these funds, you can:
- Document exactly how much of your retirement you want each of your loved ones to receive
- Control when they receive the funds outright
- Easily update and change the terms of your Trust concerning when and how they will have access to the funds. This is a huge advantage if you are leaving money to your children through your retirement accounts.
Beneficiary Designations Always Trump Your Will
Whether you have an employer-sponsored 401K or an IRA you manage yourself, there is one critical rule that everyone needs to know: beneficiary designations trump your Will.
A Will is an important estate planning tool, but most people don’t realize that their retirement accounts don’t pass to their relatives through their Will and that their beneficiary designations override whatever your Will says about a particular asset.
For example, if your Will states that you want all of your property to be passed on to your brother, but the beneficiary designation on your retirement account says you want it to go to your sister, your sister will inherit the account, even though your Will says that all of your assets go to your brother.
Similarly, let’s imagine that you get divorced and as part of your divorce decree your ex-spouse agrees that they will not have any right to your retirement fund. However, after the divorce, you forget to take their name off the beneficiary designation for the account. If you die before updating the beneficiary designation, your former spouse will inherit your retirement account. Then, your children, or your current spouse, will have to hire a lawyer and go to court to demand that the funds are rightfully returned to them, as you intended and in conformity with your divorce decree.
If you forget to update your ERISA-controlled account and have remarried, your current spouse would receive half of the account and your former spouse would receive the other half. That’s why it’s so important to work with an estate planning attorney who can make sure your accounts are set up with the proper beneficiary designations and to continue monitoring this throughout your life to ensure that your assets are passed on according to your wishes.
Do Not Name Your Minor Child As a Beneficiary
I’ve had many clients over the years who need to go to court and spend years paying our office attorney’s fees to conduct an annual accounting, only because their spouse or a grandparent named their children as a beneficiary of their retirement account or life insurance policy. I literally have one of these cases that I am managing right now, and it is always a terrible discussion to be had on the inner-workings of what is required. The fact of the matter is: Minors cannot legally own property and if you’ve named them directly as a beneficiary, you are creating a huge problem for your family and requiring that a minor’s guardianship is established. Please do not do this and give us a call to help you if you don’t understand why, or what your alternative options are to ensure your minor children can receive your life insurance or retirement benefits without mandating that your family will have to pay lawyers and go through a minor’s guardianship until they turn 18.
Work With An Attorney Who Makes Sure All Your Assets Will Be Passed On How You Want Them To
Understanding how the law affects different types of assets is essential to creating an estate plan that will work for you and your family. But there’s more to it than just having a lawyer – you need an attorney who takes the time to really understand your family and your assets so they can design a custom and personalized plan that achieves your goals for your assets and your legacy. Shockingly, most estate planning lawyers do not do this and they do not take the time to review their clients assets or educate them on how to navigate these minor details that will make all the difference when your plan will be put into action.
That’s why we’re different. We take the extra time to educate our clients, create an inventory of all of their assets and discuss each one with them to ensure that every asset they hold is accounted for and passed on to their loved ones exactly as they want it to. Then, even if they don’t listen to us and take action on these tasks right away, we remind them of what needs to be done to manage their estate plan properly every three (3) years, at no charge, to ensure that their assets are managed in the way they should be.
If you’d like to learn more about how to protect your retirement accounts, maximize the tax benefits or to learn more about how we serve our clients differently than the traditional and stereotypical lawyer; schedule a complimentary call with us. We’d be honored to share how our unique process can help your family.
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This article is a service of Family Wealth & Legacy Legal Solutions (FWLLS). At FWLLS, we do not just draft documents; we ensure you make educated, informed and empowered decisions for yourself and the people you love. That’s why we offer a Family Wealth & Legacy Strategy Session™, during which you will get educated and begin to prepare to avoid life’s most common legal problems and get a plan in place to make the best possible choices for the people you love. You can begin by calling our office today to schedule a Family Wealth & Legacy Strategy Session and mention this article to find out how to get this $750 session at a significantly discounted rate, or even for free.