U.S. workers have stashed $6.9 trillion in their 401(k) plans as of Sept. 30, 2023, according to the Investment Company Institute, an association representing regulated investment funds.
A healthy chunk of those 401(k) assets is being steered toward spouse and non-spouse beneficiaries who take over the plans after the original account holder passes away.
All beneficiaries should understand the rules surrounding inherited 401(k) plans, which requires some homework.
“Naming a beneficiary to a 401(k) allows the plan participant to designate who will receive the plan balance at death. Having a plan recipient means the account avoids the probate administration process,” says David T. DuFault, an attorney at Sodoma Law in Charlotte, North Carolina. “As long as the named beneficiary survives the plan participant, he or she will receive the plan balance.”
Failure to name a beneficiary will most likely lead to the account balance being distributed to the plan participant’s estate, which has numerous disadvantages. “Those drawbacks include exposing the account to probate and estate creditors, increased costs and likely a shortened withdrawal period,” DuFault says.
How can 401(k) beneficiaries and the original plan account holder get the transfer process right? Retirement planning experts suggest following these guidelines.
- Designate a beneficiary.
- Think carefully when choosing a beneficiary.
- Update beneficiaries after major life events.
- Understand 401(k) and IRA plan differences.
- Talk to your beneficiary.
- Understand tax implications for beneficiaries.
Designate a Beneficiary
The process of designating a beneficiary for a 401(k) typically occurs when the original plan holder first enrolls.
“Upon enrolling in your 401(k) plan with your employer, you will be asked to name your beneficiary or beneficiaries,” says Theresa Becker, a certified financial planner at Rockland Trust in Boston. “If the plan holder doesn’t complete that task and passes away, plan assets distribution is determined by the default beneficiaries set out in the employer’s retirement plan document.”
Default beneficiary designations may include these:
- If the owner is married, the default beneficiary is the spouse.
- If the spouse is deceased, the assets are split equally between the remaining family children.
- If no children remain, then the 401(k) plan assets go to the estate.
“Even if this default process is followed, the plan beneficiary generally will not be able to take ownership until after the probate process,” Becker says. “If there is a major life event, the owner’s online plan account should allow for a change in beneficiaries. These will be confirmed via email or postal mail.”
One of the benefits of beneficiary designations is that you can update them without the expense of updating your estate planning documents.
“Like any kind of estate planning, the choice of the beneficiary is generally up to the account owner, except married account owners who likely will need to provide for a spouse,” DuFault says. “Contingent beneficiaries are also important as they will receive the account if the primary (beneficiary) is deceased.”
When minors or young adults are potential beneficiaries, proper trust language should be used to avoid court-supervised control of withdrawals and distributions.
“Additionally, as part of the ongoing review of beneficiary designations, life events such as births, deaths, marriages and divorces for both the participant and the intended beneficiaries should be considered,” he adds.
