Nobody wants to think about dying. That’s one reason why many of us procrastinate in putting together an estate plan.
Another factor, of course, is the cost and the time it takes to set one up.
But there’s an easy way to put together a plan that upon your death would easily transfer the lion’s share of your financial assets simply and directly to the right person. Even those who have taxable accounts can set clear instructions on how to disburse their money without writing a will and having your estate go to probate, which can mean months of delays for your heirs.
That’s not to say a will (or a living trust) isn’t desirable; it’s actually preferable in some cases, because it sets up clear instructions in a legal document that can make a wealth transfer ironclad. I also recommend consulting a trust and estates attorney especially if you have substantial assets in complicated financial instruments, an atypical family situation or a potential heir who requires custodial care. But short of that, you can easily make clear, legal instructions on how you want the vast majority of your estate to be distributed upon your death.
One of the simplest estate planning tools around is the beneficiary designation you have to fill out for your retirement accounts. Many people don’t give them much thought, but beneficiary designations for insurance policies, annuities, and retirement accounts are legally binding, and outweigh any will when it comes to distributing the assets in your estate.
That’s why you should carefully consider where those assets will go. Let’s start with retirement accounts, which are the main source of financial wealth for many Americans. And here we have to make a distinction between traditional retirement accounts like IRAs and 401(k)s, built on pretax contributions, and Roth IRAs, which are funded with after-tax income or assets.
Beneficiary designations for traditional IRAs, 401(k)s and the like are easy to do but they also have some limitations and the SECURE Act, passed by Congress and signed by the president in 2019, added some restrictions.
Previously, according to attorney Oren Ross of Oren Ross & Associates in Roswell, Georgia, you could leave money in a retirement account to your children and they could take it out over a lifetime. Now, “when you leave an IRA to your children, all the money has to come out within 10 years,” he told me in a telephone interview. And if a child waits until the 10th year to withdraw the money, he or she would be hit by a big tax bill for taking all that income in a single year.
That’s because, remember, IRAs and 401(k)s are tax-deferred, not tax-exempt, accounts and the government has been waiting for its cut for years. “They’re basically trying to prevent generational passing of untaxed money,” Ross said.
The new restrictions don’t apply to designated minor children, your spouse or any sibling whose age is within 10 years of your own. They still have to pay the taxes, of course, but can withdraw the assets left to them over their lifetimes, minimizing the tax liabilities in any one year.
So, if you want to leave money to your spouse or close sibling, the traditional IRA or 401(k) is the place to do it. These tax-deferred vehicles are also good places to designate charities as beneficiaries, if you’re so inclined. Charities, Ross told me, also have to take out the funds within 10 years, but they’re much better equipped to manage the tax liability than individuals are.
Roth IRAs and nonretirement accounts are more suitable for passing on wealth to children or grandchildren. With a Roth IRA, said Ross, the funds “still have to be distributed within 10 years, but since that money has already had the taxes paid on it, the distributions are tax-free, so you can leave it in the Roth and let it grow and then take all of the money out in a lump sum with no tax consequence.” That money can be used for anything—college tuition, a down payment on a house, or a retirement account for the child or grandchild.
There are no restrictions on money in nonretirement accounts, either, up to the limits of the estate tax, which is $11.7 million ($23.4 million for married couples) in 2021. And there’s a way to pass on that money easily, too, whether it’s in a bank, a fund company or brokerage firm. “They have something called a POD form, payable on death,” Ross explained. “It’s also known as a poor man’s trust. It avoids probate in most situations and goes directly to your beneficiaries, and yes, most people don’t know that exists.”
Well, now you do. We’ll go into how best to leave your home or other property to your heirs in the next column.