Employer-based retirement plans provide a powerful mechanism for W-2 employees to reduce their tax liability and save for retirement. But far too often people do not take advantage of this important benefit. The reasons for not participating or under-participating are varied, but many lose out because they imagine using a 401 (k) to be a difficult and complex process. And, based on this assessment, decide it is not worth it and not for them. Others believe there is no benefit to long-term investment. These perceptions is understandable, but are demonstrably incorrect and harmful. Utilizing a 401(k) is generally straightforward and impactful. Moreover, it generally only requires four decisions:
- Decision #1: How Much to Save?
- Decision #2: Which Contribution Option is Right?
- Decision #3: How to Invest?
- Decision #4: Who Will Be the Beneficiary?
This article is the fourth in a series and focuses on Decision #4.
What is a Beneficiary Designation?
A beneficiary designation is an estate planning device that allows for the transfer of assets to heirs upon death. Generally speaking, a beneficiary designation concerns a particular asset or set of assets, unlike a will which may address a wide range of assets or sets of assets. In connection with a 401(k) plan, beneficiary designations direct in what amounts and to whom those 401(k) assets should be transferred upon the account owner’s death.
What is the Advantage of a Beneficiary Designation?
Generally speaking, the principal advantage to using a beneficiary designation to transfer 401(k) assets upon death is that a beneficiary designation can transfer assets without need for probate. Thus, with an appropriate beneficiary designation, heirs can receive 401(k) assets with minimal court interference. Thus, a beneficiary designation can save time, money, and the possible heartache of a will contest.
Notably, if a beneficiary designation and a will conflict, the beneficiary designation will almost certainly control. This is true even if the will is more recent and more accurately reflects the decedent’s wishes.
Types of Beneficiaries
There are two types of beneficiaries: primary and contingent.
A primary beneficiary is the account holder’s first choice to receive 401(k) assets. If a 401(k) account holder is married, then, pursuant to federal law, a 401(k) account holder’s spouse is the primary beneficiary unless that spouse consents, in writing, to another primary beneficiary.
A contingent beneficiary is second in line to receive 401(k) assets if the primary beneficiary predeceases the account holder or otherwise declines to accept the 401(k) assets. If a primary beneficiary dies and no contingent beneficiaries have been named, then the terms of the plan document would apply.
How do I Choose a Beneficiary?
Choosing primary and contingent beneficiaries is a personal choice made based on a variety of personal and financial factors. Multiple people can be named in each category and the 401(k) assets can be split up amongst each category however the account holder likes. Thus, the structures and choices of beneficiary designations are endless and should be made with both financial and emotional care. In some situations, these decisions may be straightforward, while in others they may be more complex.
Regardless of who is ultimately designated, it is generally smart to name both primary and contingent beneficiaries. As noted above, absent any beneficiary designation, 401(k) assets may be subject to probate and if the decedent did not create a will, may be subject to the state laws concerning intestacy. In other words, the courts, and not the decedent, may have the last word about who receives the 401(k) assets. Moreover, probated assets may result in unexpected taxes or distribution requirements that might be avoided via a beneficiary designation.
Further, once beneficiary designations are made, they should be reviewed on a regular basis – particularly after any major life event, e.g., marriage, divorce, birth or adoption of a child. This is especially important because, as noted above, when a beneficiary designation and a will conflict, the beneficiary designation will almost certainly control.
Beneficiary designations are generally the last thing on 401(k) account holders’ minds. However, beneficiary designations are powerful estate planning tools and are significant after an account holder’s death. Thus, it is important to make beneficiary designations carefully and to regularly review them to make sure they accurately reflect wishes and estate plans.
With all of that in mind, consulting with a trusted and knowledgeable financial professional is always a good idea. They may be able to highlight any tax or other financial planning issues that could impact beneficiary designations.
Author: Jon Marquet
Jon Marquet is the Retirement Plan Consultant at Trust Point Inc. He is a licensed attorney in Minnesota, Iowa, New York, and New Jersey. He works with business owners to identify and address their needs in connection with employer-based retirement plans. He also works in concert with plan sponsors, plan participants, and others in Trust Point Inc.’s Retirement Plan Services group to initiate, administer, and regularly review client employer-based retirement plans. He has presented and written on numerous and various topics throughout his career.