What Happens to My Retirement When I Die?
If you are like most Americans, by the time you approach or reach retirement age, your two biggest assets are your home and your retirement account. If you are in the process of creating an estate plan, or are beginning to think about it, you may be asking yourself, “what happens to my retirement when I die?” Good question and, as with most questions posed on this site, the answer is “it depends.”
Traditional Pension Plans (Defined Benefit Plans)
If you receive a defined benefit plan through your employer, union or an annuity company (what’s typically called a pension) then your retirement payments will begin under the terms set out by your employer, union or the annuity company. The retirement payments will generally stop upon your death. A portion of your payments may continue to go to a surviving spouse, depending on your plan or elections you made under it.
IRAs and 401(k)s
If, like many people, you do not have a traditional pension, but instead have an employee sponsored 401(k) (or 403(b) if you are an educator or work in the non-profit world), or if you have saved for your own retirement through an Individual Retirement Account (IRA), you can begin taking penalty free withdraws for your retirement beginning when you reach age 59½. Under new federal laws (more fully described below), starting January 1, 2020 you must begin withdrawing funds from your 401(k), 403(b) or IRA when you reach 72 years of age. This is known as required minimum distributions (or RMD for short). Note: if you turned 70½ prior to January 1, 2020 your RMD is based on age 70½, not age 72.
What happens to your retirement after you die is a little more complex if your retirement funds are in an IRA or 401(k). Generally, the funds in the IRA or 401(k) will go to the person or persons you have listed as your beneficiary with the financial institution or plan administrator. If you have no beneficiary listed, or if your beneficiary dies before you, then the funds in the account will go to your estate and, after probate, will pass to your heirs or to the beneficiaries listed in your Will.
Tax Consequences for IRAs and 401(k)s
Okay, so who gets your retirement after you die is simple enough – the person or persons you list on your beneficiary forms (be sure to update your beneficiary – if your beneficiary dies before you and you don’t provide a new one, then the funds in your retirement account go to your estate and must be probated). The confusion usually comes with how the funds are received. Remember the advantage of a traditional IRA and a 401(k) is that taxes on funds put into the accounts are deferred. Note: taxes are deferred NOT done away with. When you retire and begin withdrawing funds from an IRA or 401(k) the funds that you withdraw are taxed at that time. The same is true for your beneficiaries. They are taxed on your IRA or 401(k) funds when the funds are withdrawn from the accounts and passed to your beneficiaries (exception – a surviving spouse can roll over the deceased spouse’s plan into his or her own retirement account to continue the tax deferment).
Funds withdrawn from IRAs and 401(k)s are treated and taxed as income. As with any income, the amount received in any given year determines your tax bracket and thus, the amount of taxes you have to pay. It is therefore beneficial (from a tax standpoint) to stretch out the withdrawals from an IRA or 401(k) over as many years as possible. However, the rules on how long distributions from an IRA or 401(k) were greatly changed starting in 2020.
No More Stretch? The SECURE Act Changes Retirement Laws
The Setting Every Community Up for Retirement Enhancement (SECURE) Act of late 2019 makes some major changes in how 401(k) and IRA accounts can be distributed upon someone’s death. The SECURE Act, which took effect January 1, 2020, puts restrictions on who can “stretch” out the withdrawal period for an inherited 401(k) or IRA. Under the new rules some beneficiaries must now withdraw all funds in an inherited retirement account within ten-years of the original account owner’s death.
A Little Background on 401(k) and IRA Withdrawal Rules
Traditionally, money left in your 401(k) or IRA account after you die could be paid out to your beneficiaries over a period of many years. This allowed your beneficiaries to have a steady stream of income over their life-time (assuming the funds were available in your retirement account) and greatly lessened the tax burden of the withdrawals. This was known in estate planning and financial planning circles as a “stretch” because the beneficiaries were able to stretch out the withdrawal of funds from the account over many years. Beginning the first of 2020, Congress changed the rules.
New Rules Under the SECURE Act
The SECURE Act, in an effort to increase revenue (i.e. taxes), now requires certain beneficiaries of a 401(k) plan or IRA to withdraw all of the funds in the retirement account within ten years of the original account holder’s death. The new law does away with the Required Minimum Distribution (RMD) (https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-required-minimum-distributions) rules for these beneficiaries. This means that no minimum amount has to be withdrawn from the inherited retirement account each year during the ten-year period. However, all of the money in the account has to be withdrawn after ten-years. If the inherited account is large, this could result in a large tax burden on the beneficiaries of the account.
Who is Affected by the SECURE Act?
The good news is that the new withdrawal rules of the SECURE Act do not affect all beneficiaries. The new ten-year withdrawal requirement does not apply to: (1) the original account holder’s surviving spouse; (2) a disabled beneficiary; (3) a chronically ill beneficiary; and (4) a beneficiary who is not more than ten-years younger than the original account holder. Also, if the 401(k) or IRA account holder dies leaving minor children as beneficiaries, the ten-year withdrawal period does not begin for those children until they become adults.
What is the Impact of the SECURE Act on Special Needs Trusts?
The impact of the new SECURE Act withdrawal provisions are likely to be minimal on Special Needs Trusts. The disabled beneficiary of the Special Needs Trust should still be able to enjoy the benefit of stretching out inherited 401(k) and IRA withdrawals over their lifetime. Provisions in the SNT that provide for remainder beneficiaries may need to be reviewed and amended. Be sure to look back at this blog, as I will continue to provide updates as the new law develops and it becomes clearer how it will impact Special Needs Trusts.
What About Other Trusts?
A trust can be listed as a beneficiary to your IRA or 401(k). However, the trust must follow the same withdrawal rules as individuals. If the persons who benefit from the trust are not an exempted class, then the trust will have to receive all of the distributions from your IRA or 401(k) within ten years. Traditionally, it was common to list a trust a beneficiary for estate planning purposes, to protect heirs from creditors and to make sure the money from your retirement accounts were spent by heirs per your wishes. If you have designated a trust as the beneficiary of your retirement accounts, it may be time to review that trust and to make some changes due to the new rules. Even though your trust may need to be updated, there may still be options to ensure that your estate plan is carried out per your wishes and to minimize tax consequences for your heirs.
Remember that if you list no beneficiary on your retirement account (or your named beneficiary dies before you) then the funds in your IRA or 401(k) will have to go through probate before they can be distributed. Although probate is not as complicated today as it once was, it still can be time consuming and costly. Further, if you do not have beneficiaries listed on your retirement account, the funds may not end up going where you wish them to.
The Take Away
Your take away should be that if you are planning on using your 401(k) or IRA as a long-term estate planning strategy for leaving a life-time source of income for young family members, such as grandchildren, under the new SECURE Act the rules have changed and it may be time to review and update your estate plan. If you would like to schedule a time to speak with our firm about your estate plan or other legal needs you can do so by calling us at (501) 891-6000 or booking an appointment here https://whlawoffices.com/schedule/
These are difficult and uncertain times. Coping with the Corona Virus and COVID-19 can be stressful and down right scary. With the focus now on the health of you and your family, estate planning may be the last thing on your mind. Even if you are wishing to create an estate plan, social distancing and stay at home orders may make it hard for you to meet with an attorney or sign your Will or other estate planning documents. Fortunately, if you live in Arkansas, Governor Hutchinson just signed an Executive Order making it easier for Arkansans to complete estate planning documents from the comfort and safety of their own homes.
As is more fully explained below, ordinarily your Last Will and Testament must be signed in the presence of two witnesses, who must also sign the document swearing that they witnessed your signature. Also, other estate planning documents, such as trusts, powers of attorney, living wills and advance directives, need to be signed in the presence of a notary public. The Governor’s Executive Order 20-03 allows witnesses to Wills and notaries to remotely witness signatures through video conferencing. The Governor’s order will remain in effect as long as the COVID-19 emergency continues.
Executive Order 20-03 requires that both the signor and the witnesses and/or notary be physically present in Arkansas when the documents are signed. The executive order also requires that the video conference have both video and audio capabilities. Further, the executive order requires that a notary validate the identity of the person signing the document. If the person signing the document is not already known to the notary, then they will have to show the notary a driver’s license or other valid form of identification by placing the I.D. in front of the video camera so that it can be remotely seen by the notary.
Executive Order 20-03 also allows documents to be signed in counterparts. Signing in counterparts means that the document can be signed and then an exact copy of the document can be signed by the witness or notary in a separate location and the copy can be later attached to the original. The executive order specifically states that it includes deeds, Last Wills and Testaments, durable powers of attorney, and health care proxies. Be aware, even with the new rule, if the document states that it cannot be signed in counterparts, then it cannot be.
The executive order does not apply to all notaries. Only notaries who are or work for attorneys, title agents, or financial institutions can use the new video conference rules. Other notaries will still have to witness someone’s signature in person.
Arkansas law sets out that to be valid, a Will must be signed by the creator. If the creator is too weak to sign, the Will can be signed by someone else in the creator’s presence, with the creator’s permission. Unless the Will is Holographic (i.e. a handwritten Will), the signature of the creator must be witnessed by two disinterested persons. The witnesses must be at least eighteen years old and of sound mind. They must be disinterested, meaning that they do not benefit from the Will. Finally, the creator must state in the presence of the witnesses that this is his or her Will.
The Will does not have to be notarized. However, the Will can have something known as a Proof of Will attached to it. A Proof of Will is a notarized statement by the witnesses that they were present when the Will was signed and that they witnessed the creator sign the Will and that the creator appeared of sound mind and legal age at the time of signing. See Ark. Code Ann. § 28-25-106.
With the new Executive Order 20-03 both the witnesses to the Will and the Notary Public can be “present” as long as they can see and hear the creator over the internet, which can be accomplished through an app such as Zoom, Skype or Facetime.
The purpose of an estate plan is to make your wishes known and make sure your property goes to who you want it to after you die. A well drafted estate plan can also avoid the need for probate administration, which can be a costly and time consuming process. An estate plan may include documents such as a Last Wil and Testament, a Trust, a Power of Attorney, a Healthcare Directive, and a Living Will. Your estate plan may also include deeding or titling your property in such a way that your family and loved ones receive it upon your death without the need for probate.
Even if you aren’t worried right now about what happens to your property when you die, you should consider what would happen with your finances and your healthcare decisions if you become too sick to managing your own affairs. Property placed in a trust can be managed by someone else if you become incapacitated. Also, if you have a durable power of attorney, your agent in that document can manage your property per the wishes you set out in the power of attorney if you are unable to do so. If you are unconscious or incapacitated and unable to make healthcare decisions for yourself a healthcare proxy or advance care plan can give someone else authority to make healthcare decisions for you. A living will lets your healthcare proxy and your doctors know how you want to be treated and cared for if you can no longer convey your wishes because you are unconscious or incapacitated. If you do not have a trust, power of attorney and/or healthcare directives in place, and you become incapacitated, then your loved ones may have to petition a court to obtain guardianship over you before they can help with your finances or healthcare decisions.
If you are thinking of creating an estate plan or if you need to modify your current estate plan, our office can help. We can schedule phone or video conference meetings with our experienced attorneys and can provide your important estate planning documents to you via the internet. We can also set up the required video conferencing needed to ensure your documents are properly witnessed and notarized so that they are effective when needed.
Remember in these trying times we are all in this together. Please stay safe. Thank you for trusting us with your estate planning and other legal needs. We are open during this crisis and here to help you get through it.