Selecting beneficiaries for retirement benefits is different from choosing beneficiaries for other assets such as life insurance. A 401k beneficiary is the person, trust, charity, or other entity you name to receive your 401(k) benefits after you pass away, and that designation can carry very different tax and legal consequences than other beneficiary choices.
With retirement benefits, you need to know the impact of income tax and estate tax laws to select the right beneficiaries. Although taxes shouldn’t be the sole determining factor in naming your beneficiaries, ignoring the impact of taxes could lead you to make an incorrect choice and change how much your heirs receive, when distributions must be taken, and whether your assets pass efficiently under your estate plan.
In addition, if you’re married, beneficiary designations may affect the size of minimum required distributions to you from your IRAs and retirement plans while you’re alive. This article covers the decisions that matter most: naming and changing beneficiaries, choosing primary and contingent beneficiaries, weighing spouse, trust, and charity options, understanding the SECURE Act, and avoiding unnecessary probate and administrative complications.
Here are some things to consider when choosing a beneficiary for your IRA or 401(k).
Paying Income Tax on Most Retirement Distributions
Most inherited assets such as bank accounts, stocks, and real estate pass to your beneficiaries without income tax being due.
However, that’s not usually the case with 401(k) plans and IRAs.
Distributions from a traditional 401(k) are taxed as ordinary income, and beneficiaries will owe income tax on withdrawals from pre-tax 401(k) accounts and traditional IRAs. With Roth IRAs and Roth 401(k)s, however, inherited distributions may be tax-free if the applicable conditions, including a five-year holding requirement, are met. See IRS guidance on designated Roth accounts for details.
That means you need to consider the impact of income taxes when designating beneficiaries for your 401(k) and IRA assets. For example, if one of your children inherits $100,000 cash from you and another child receives your pre-tax 401(k) account worth $100,000, they aren’t receiving the same amount.
The reason is that all distributions from the 401(k) plan will be subject to income tax at ordinary income tax rates, while the cash isn’t subject to income tax when it passes to your child upon your passing.
Similarly, if one of your children inherits your taxable traditional IRA and another child receives your income-tax-free Roth IRA, the bottom line is different for each of them.
Naming or Changing Beneficiaries
When you open up an IRA or begin participating in a 401(k), you are given a beneficiary form to complete to name your beneficiaries. Changes are made in the same way, by completing a new beneficiary designation form. Your 401(k) beneficiary designation overrides instructions in a will or trust.
However, spouses may have special rights under federal or state law. It’s a good idea to review your beneficiary designation form at least every two to three years and after major life events such as marriage, divorce, or the death of a beneficiary. Outdated beneficiary designations can lead to unintended legal consequences.
Also, be sure to update your form to reflect changes in financial circumstances. Accurate beneficiary designations can help avoid the delays and costs associated with probate. Beneficiary designations are important estate planning documents. Seek legal advice as needed.
Designating Primary and Secondary Beneficiaries
If you don’t have a named beneficiary who survives you, your estate may end up as the beneficiary, which is not always the best result.
Your primary beneficiary is your first choice to receive retirement benefits. You can name more than one person or entity as your primary beneficiary.
If your primary beneficiary doesn’t survive you or decides to decline the benefits (the tax term for this is a disclaimer), then your secondary (or “contingent”) beneficiaries receive the benefits.
Having Multiple Beneficiaries
You can name multiple beneficiaries for your 401(k) account to share in the proceeds. You just need to specify the percentage each beneficiary will receive (the shares do not have to be equal).
You should also state who will receive the proceeds should a beneficiary not survive you. In some cases, you’ll want to designate a different beneficiary for each account or have one account divided into sub accounts (with a beneficiary for each subaccount).
Keep in mind: Due to legislation passed at the end of 2019 (the SECURE Act), most non-spouse beneficiaries who inherit a 401(k) or IRA from someone who died after 2019 must withdraw the entire balance by the end of the 10th year after the year of death (previously, they could generally take distributions according to their life expectancies). If the original owner had already reached his or her required beginning date for required minimum distributions (RMDs), the beneficiary must also take annual RMDs in years one through nine. Certain eligible designated beneficiaries, including a minor child of the owner (until age 21), a disabled or chronically ill individual, and anyone not more than 10 years younger than the owner, may still qualify to take distributions over a life expectancy. The IRS summarizes these rules for retirement account beneficiaries.
Avoiding Gaps or Naming Your Estate as a Beneficiary
Probate is the court process by which assets are transferred from someone who has died to the heirs or beneficiaries entitled to those assets. There are two ways your retirement benefits could end up in your probate estate:
- You might name your estate as the beneficiary.
- If no named beneficiary survives you, your probate estate may end up as the beneficiary by default.
If your probate estate is your beneficiary, several problems can arise.
If your estate receives your retirement benefits, the opportunity to maximize tax deferral by spreading out distributions may be lost. In addition, probate can mean paying attorney’s and executor’s fees and delaying the distribution of benefits.
Naming Your Spouse as a Beneficiary
When it comes to taxes, your spouse is usually the best choice for a primary beneficiary, and under federal law a spouse is generally automatically entitled to that role for a 401(k) unless he or she consents in writing to another choice.
A spousal beneficiary has the greatest flexibility for delaying distributions that are subject to income tax, though plan rules vary. In addition to rolling over your 401(k) or IRA to his or her own IRA or plan, a surviving spouse who is the sole beneficiary can generally elect to treat your IRA as his or her own. Withdrawals a spouse takes as a beneficiary, directly from the inherited account, are generally free of the 10% early withdrawal penalty, though income tax still applies to taxable amounts. Once a spouse rolls the money into his or her own account or treats an inherited IRA as his or her own, however, withdrawals before age 59½ may be subject to that penalty unless another exception applies. A surviving spouse may also choose a lump sum distribution, but taking the full amount at once can create immediate taxable income and potentially push the beneficiary into a higher tax bracket.
These options can provide more tax and planning options, and proper planning when choosing beneficiaries can affect both tax implications and available choices. If your spouse is more than 10 years younger than you and is the sole beneficiary of the account, then naming your spouse can also reduce the size of any required taxable distributions to you from that account while you’re alive (see IRS Publication 590-B). This can allow more assets to stay in the retirement account longer and delay the payment of income tax on distributions.
Although naming a surviving spouse can produce the best income tax result, that isn’t necessarily the case with death taxes. Your spouse can inherit an unlimited amount of assets and defer federal death tax until both of you are deceased (Note: special tax rules and requirements apply for a surviving spouse who is not a U.S. citizen).
If your spouse’s taxable estate for federal tax purposes at his or her passing exceeds the applicable exclusion amount, then federal death tax may be due. For 2026, the federal basic exclusion amount is $15 million per person, so this mainly affects larger estates, although some states impose their own estate or inheritance taxes at lower thresholds.
In other words, one possible downside to naming your spouse as the primary beneficiary is that it may increase the size of your spouse’s estate for death tax purposes, which in turn may result in death tax or increased death tax when your spouse passes.
Naming Other Individuals as Beneficiaries
You may have some limits on choosing beneficiaries other than your spouse.
For most 401(k) plans, federal law dictates that your surviving spouse be the primary beneficiary of your entire account no matter where you live, unless your spouse signs a timely, effective written waiver witnessed by a plan representative or notary. Naming someone else as primary beneficiary requires that consent. Some plans, such as governmental plans and church plans that have not elected to follow these federal rules, are not covered, and a plan may choose not to apply the rule until you have been married for one year. And if you live in one of the community property states, your spouse may have rights related to your IRA regardless of whether he or she is named as the primary beneficiary.
Keep in mind: A non-spouse beneficiary cannot roll over your 401(k) or IRA to his or her own IRA. However, after the original account owner’s death, a non-spouse beneficiary can move inherited 401(k) assets into an inherited IRA set up for his or her benefit through a direct trustee-to-trustee transfer, and federal law has required qualified plans to offer this option since 2010. Withdrawals from inherited accounts are generally free of early withdrawal penalties, although taxable distributions are still subject to income tax. To claim funds, beneficiaries typically must notify the plan administrator and submit required paperwork, such as a death certificate, for an inherited 401(k).
Naming a Trust as a Beneficiary
You must follow special tax rules when naming a trust as a beneficiary, and there may be income tax complications. Seek legal advice before designating a trust as a beneficiary. The same caution applies if you name a minor child directly, because a child cannot control inherited assets and that can create legal complications.
Naming a Charity as a Beneficiary
In general, naming a charity as the primary beneficiary will not affect required distributions to you during your lifetime.
However, having a charity named with other beneficiaries on the same asset could affect the tax-deferral possibilities of the non charitable beneficiaries, depending on how soon after your passing the charity receives its share of the benefits.
Conclusion
It can take a lot of rumination to decide on the right beneficiary.
As experienced financial professionals, we help clients like you figure out the best retirement plan for their situation, so that when they’re ready they can retire gracefully with peace of mind.
Please connect with us and let us help you plan for your dream retirement. We would be delighted to go on the journey with you.
Important Disclosure: This material is provided for general informational and educational purposes only and should not be construed as individualized investment, tax, or legal advice. Investment strategies involve risk and may not be appropriate for every investor. Tax results depend on individual circumstances and applicable law. Confidence Wealth Management does not provide legal advice. Consult appropriate investment, tax, and legal professionals before implementing any strategy discussed.
