Avoiding Probate with Retirement Plan Assets

Retirement Plan Assets (IRAs, 401(k)s, 403(b)s, Keoghs, and the like) can be problematic. Because these contain money that has not yet been taxed for income tax purposes, we need to consider the income tax effect of gifts of these assets.  Many times, retirement plan assets should be left to individuals or charities through beneficiary designations and not through a will or a trust.

The income tax impact can be horrendous.  We were recently involved in a substantial estate where almost all of the assets were in the form of plan assets.  While the value of the assets were well in excess of the value of the gifts to the beneficiaries of a trust, once the income tax impact was factored in, some of the beneficiaries got only 75¢ on the dollar.

This is because the value of the plan assets is taxable as income to the estate or trust, and if an estate has more than $11,950 in income, the tax rate is 39.9%!  If you have $1,000,000 in your IRA and it is paid to your estate, roughly $398,000 will be paid in taxes, leaving $602,000 for your beneficiaries.

Most retirement plans permit the designation of a beneficiary or beneficiaries.  This is one type of asset that you really want to make sure you have designated beneficiaries, other than your estate or your trust.

If you have a charitable inclination, it is best to direct plan assets to the charities, and leave other assets to your other beneficiaries.  The charities do not have to pay income tax on their gifts.  If you have all your plan assets dump into your estate, there will be less money for everyone than if you had the plan assets payable to the charities.

If you do not plan to leave anything to charities, usually it is best to name individuals as beneficiaries of your plan assets.  Most beneficiaries will be in a lower income tax bracket than the estate or trust, and many times they will have the ability to stretch the payout of the plan account over his or her lifetime.

Planning for gifts of plan assets can be complex.  We can help you with planning for these assets if you contact us.