Everyone should have a will.
It’s the most basic component of an estate plan. In it, you set forth your directions on how your property should be distributed after you die, who should manage your affairs, who should take care of your children, etc.
However, in some cases your will does not cover all of your property. Certain property will pass outside your will. The legal system calls this property “non-probate assets,” because it passes outside probate by law. In other words, the legal directions regarding this property take precedence over the directions you set forth in your will.
Examples of non-probate assets include joint property with a right of survivorship. If a married couple buys a house together, and the husband dies, the house usually passes by law to the wife. Another example is a bank account with a payable on death (POD) beneficiary. If you have a bank account and you designate your brother as POD beneficiary, but your will says that everything goes to your child, then usually when you die the bank account will still go to your brother. Likewise for a life insurance policy, if you have a designated beneficiary on that policy.
One type of asset where this becomes especially important is tax-advantaged retirement accounts, like an individual retirement account (IRA), Roth IRA, 401(k) account, etc. These accounts get favorable tax treatment. That tax treatment of retirement accounts is described in detail elsewhere, but essentially, these accounts typically let you defer paying taxes until later, allowing your investments to grow with money that would have gone to taxes. Or they allow you to pay taxes now, and avoid paying taxes later on your investment gains.
The bottom line of this favorable tax treatment is that it’s usually more profitable to keep your money in these accounts longer, and delay taking withdrawals for as long as possible.
If you pass away, and you still have money in these retirement accounts, for some accounts you have to distribute the entire remaining balance of the accounts within five years. Unless you have a designated beneficiary on the account. If so, and if the account is set up right, it can be transferred to that beneficiary, and be distributed over that beneficiary’s lifetime. That means it may be able to distribute the account over forty years, instead of five. That could result in enormous gains – depending on how the numbers play out, tens of thousands, hundreds of thousands, or even millions of dollars.
So there are compelling reasons to have a designated beneficiary on your retirement accounts. That said, doing so means the account will go to the beneficiary, and not pass under your will. Your will can include safety measures like trusts, in case the beneficiary shouldn’t receive the money – for example, if they’re too young to wisely manage it, or they are irresponsible with money, or they have a drug problem and shouldn’t have access to a large amount of money, or they receive government benefits that they would lose if they receive a large sum of money.
Leaving the property directly to a beneficiary circumvents the trusts that would protect the beneficiary in these scenarios.
It’s possible to instead leave retirement accounts to a trust, and still get favorable tax treatment, but the trust has to be set up properly.
The bottom line is that retirement account designations, as well as a will and other non-probate assets, are part of a hollistic estate plan. If you want to get started crafting yours, or it’s time to review your estate plan, FriedmanLaw is available to help. Call or email us today.