Keeping Retirement Benefits Out of Probate

Human Hand Drawing Retirement Plan Growth Concept On NotebookAvoiding probate is a priority for many people when making their estate plans. Probate is the court-supervised process of identifying, gathering, and distributing a person’s assets after their death. While many states have simplified their probate procedures, going through probate can still be a time-consuming and costly process. Accordingly, most people try to keep assets out of probate if they can. One question we frequently get is about keeping retirement benefits out of probate.

The good news is that most retirement benefits do not go through probate. Retirement plans such as IRAs and 401(k)s have beneficiary designations. You can designate a person to receive any remaining benefits in the plan after your death, and those assets generally pass directly to that person without any probate involvement whatsoever.

The bad news is that there are ways for retirement benefits to end up in probate after all—and the worse news is that those assets are often considerable, and if they go through probate, your creditors may take a chunk out of them. Let’s talk about keeping retirement benefits out of probate.

Naming a Beneficiary for Your Retirement Account

Most people choose to name an individual, usually a spouse, as the beneficiary of their retirement accounts. In fact, if you have a 401(k), you must name your spouse as beneficiary unless your spouse signs a written waiver.

If you name one or more beneficiaries to your retirement account, they take the assets when you die, and there is no probate. However, if you name a beneficiary and he or she predeceases you, and you have not named a contingent (alternate) beneficiary, your estate will become the beneficiary—and the assets in your retirement account will go through probate.

Some people make the mistake of naming their estate as the beneficiary or contingent beneficiary of their retirement accounts, with the same result. The bottom line is that there is little benefit to naming your estate as the beneficiary on your accounts, and a lot of risk, including the risk of creditors being able to make a claim against the money you intended for your family.

If you name one of your children as a beneficiary and he or she is a minor when you die, unless you have made formal arrangements for a legal adult to manage your child’s assets, guess what happens? That’s right: the benefits must go through probate so the court can appoint someone to manage them for your child.

If you have retirement accounts, you should contact your plan administrator to review your beneficiary designations. You should have at least one primary and one contingent beneficiary, who should be legal adults.

Also, if you have been through a divorce, you should make sure your former spouse is no longer named as beneficiary. The law may prevent them from claiming the benefits, but it could take a long and expensive lawsuit to do so. It’s best to make sure your beneficiary designations are up to date so litigation and probate are not necessary.

Should You Name a Trust as Beneficiary of Your Retirement Account?

One of the most common techniques for avoiding probate is the creation of a living trust. Assets placed in the trust pass outside of probate. What’s more, you can change your beneficiaries simply by changing the trust instrument. You can also create a “pour-over” will for any assets that you own outside of the trust, which places them in your trust upon your death.

It might seem that a trust would be an appropriate beneficiary for your retirement accounts, too. There are some potential advantages to this plan, but there are also possible pitfalls. With retirement plans, beneficiaries do not receive the entire inherited benefit outright. They must take required minimum distributions (RMDs) annually based on their age and life expectancy. Distributions typically take place over many years.

With a trust, however, there is no life expectancy. Trusts that are named as the beneficiary of a retirement account have shorter distribution periods, which means that more money is being distributed each year within that period. In turn, this means that benefits are usually taxed at a higher income tax rate.

The primary reason to consider naming a trust as the beneficiary of your retirement plan is for asset protection. A properly-drafted trust can shield the assets in your plan from creditors, divorce, business failures, and lawsuits. Whether the benefit of this protection outweighs the likelihood of increased income tax will depend on your particular circumstances.

Another reason to name a trust as beneficiary of your retirement accounts is so that benefits can be distributed at different times depending on the ages of the beneficiaries of the trust. This is especially helpful if some of your trust beneficiaries are minors.

It is not difficult to keep your retirement benefits out of probate, but make sure that you don’t encounter other problems in your efforts to do so. The law in this area can be complex, and it is in your best interests to consult an experienced estate planning attorney to ensure your retirement benefits pass as you intend them to.

If you have questions about keeping retirement benefits out of probate, we invite you to contact our law office.