Estate Planning for Retirement Accounts: IRAs, 401(k)s, and More

Retirement accounts often make up a significant portion of a person’s wealth. Individual retirement accounts (IRAs), employer‑sponsored plans like 401(k)s and 403(b)s, and similar tax‑deferred or tax‑free vehicles offer tremendous advantages during your lifetime. However, mistakes in naming beneficiaries or coordinating these accounts with your estate plan can cause unnecessary taxes, delays, or unintended recipients. This guide explains how retirement accounts fit into estate planning, how beneficiary designations work, and strategies to ensure your retirement savings pass to the right people in the most tax‑efficient way.

Why Retirement Accounts Are Different

Unlike most of your assets, retirement accounts pass to heirs via beneficiary designations rather than your will or trust. If you name a beneficiary on the account, that person has the right to receive the funds directly when you die. If no beneficiary is named, or if the beneficiary predeceases you without a contingent beneficiary, the account often defaults to your estate, requiring probate and potential tax acceleration. Retirement accounts also have unique income tax rules that affect both you and your beneficiaries.

Types of Retirement Accounts

• Traditional IRA: Contributions may be tax‑deductible, and earnings grow tax‑deferred. Withdrawals are taxed as ordinary income. Required minimum distributions (RMDs) begin at age 73 (or 72 depending on birth year).

• Roth IRA: Contributions are made with after‑tax dollars, and qualified withdrawals (including earnings) are tax‑free. There are no RMDs during the owner’s lifetime, making Roth IRAs a valuable estate planning tool.

• 401(k), 403(b), 457 Plans: Employer‑sponsored plans allow tax‑deferred contributions and employer matches. Withdrawals are taxed as ordinary income. RMDs apply after retirement. Some plans require spousal consent to name a non‑spouse beneficiary.

• SEP and SIMPLE IRAs: Retirement plans for small businesses and self‑employed individuals. Similar tax treatment to traditional IRAs.

Each account type has different rules about contributions, RMDs, and beneficiary options. Estate planning must account for these differences.

Understanding Beneficiary Designations

Beneficiary designations override the instructions in your will or trust. When setting up or updating retirement accounts:

• Primary beneficiary: The person or entity first in line to receive the account. You can name multiple primary beneficiaries and specify percentages.

• Contingent beneficiary: The person or entity that receives the account if all primary beneficiaries predecease you or disqualify themselves.

• Per stirpes or per capita: Determine how shares pass if a beneficiary dies before you. Per stirpes means a deceased beneficiary’s share goes to their descendants; per capita divides the share among remaining beneficiaries.

Keep beneficiary forms up to date. Review them after major life events like marriage, divorce, births, deaths, or adoption. Failing to name a beneficiary or relying on outdated forms can result in assets going to unintended recipients or being subject to probate and higher taxes.

The SECURE Act and Inherited IRAs

In 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act significantly changed the rules for inherited retirement accounts. The law eliminated the “stretch IRA” for most non‑spouse beneficiaries, replacing it with a 10‑year rule. Key points include:

• Spouses: Spousal beneficiaries can still roll over an inherited IRA into their own IRA and stretch distributions over their lifetime. They can also remain as a beneficiary and delay distributions until the deceased spouse would have turned 73.

• Eligible Designated Beneficiaries (EDBs): Certain beneficiaries can still take distributions over their life expectancy rather than within 10 years. EDBs include surviving spouses, minor children (until they reach majority), disabled or chronically ill individuals, and beneficiaries not more than 10 years younger than the account owner.

• Other beneficiaries: Most non‑EDB beneficiaries must withdraw the entire account within 10 years after the owner’s death. They can take distributions at any time during the 10 years, but the account must be emptied by year 10. This can accelerate income taxes.

• Estates, charities, and certain trusts: If the estate is named or if a non‑qualified trust is the beneficiary, the account must generally be distributed within five years (if the owner died before the required beginning date) or over the remaining life expectancy of the owner (if after the required beginning date). Such arrangements often result in less flexibility and higher taxes.

Understanding these rules is crucial when naming beneficiaries. It may be beneficial to designate certain beneficiaries directly (e.g., a spouse) while using trusts for minors, special needs individuals, or to control distributions for spendthrift heirs.

Naming a Trust as Beneficiary

Sometimes it’s beneficial to name a trust as the beneficiary of a retirement account, especially when the beneficiary is a minor, has special needs, or cannot responsibly manage money. To preserve tax advantages, the trust must meet “see‑through” requirements:

• The trust must be valid under state law.

• The trust must be irrevocable or become irrevocable upon the owner’s death.

• Trust beneficiaries must be identifiable.

• Trust documentation must be provided to the plan administrator or custodian by October 31 of the year following the owner’s death.

There are two main types of see‑through trusts for retirement accounts:

1. Conduit (or Pass‑Through) Trust: Requires the trustee to distribute all retirement account withdrawals to the trust’s primary beneficiary. Under the SECURE Act’s 10‑year rule, a conduit trust means the beneficiary will receive distributions no later than year 10, potentially receiving a large lump sum and losing ongoing asset protection.

2. Accumulation Trust: Allows the trustee to retain withdrawals in the trust and distribute them at their discretion. Accumulation trusts can preserve funds for longer periods, but trust income tax rates are higher than individual rates, so careful planning is needed.

Naming a trust involves trade‑offs between control and taxes. Consult an attorney and financial advisor before making a retirement account payable to a trust.

Mistakes to Avoid

1. Not naming beneficiaries: If no beneficiary is designated, the account may pass to your estate, triggering probate and potential five‑year payout rules.

2. Naming your estate as beneficiary: This subjects the account to probate and often results in less favorable payout periods.

3. Failing to name contingent beneficiaries: If your primary beneficiary dies before you and you haven’t named an alternate, the account could end up with unintended heirs or your estate.

4. Ignoring the SECURE Act’s 10‑year rule: Many plans drafted before 2019 assume beneficiaries can stretch distributions over life expectancy. Update estate planning documents to account for the new rules.

5. Leaving retirement accounts outright to minors: Minors cannot manage their own accounts. Court‑supervised guardianships may be required. A trust can manage the funds and distribute them at appropriate ages.

6. Naming an individual with special needs as beneficiary: A lump sum inheritance could cause loss of SSI or Medicaid. Use a special needs trust instead.

7. Failing to consider Roth conversions: Converting traditional IRAs to Roth IRAs can reduce taxes for heirs, especially if they fall under the 10‑year rule. Pay taxes now at potentially lower rates to provide tax‑free growth for beneficiaries.

8. Assuming your will or trust governs retirement accounts: Beneficiary forms control. If your estate plan says assets go one way but your beneficiary designation says another, the beneficiary form prevails.

Spousal Options

A spouse has special flexibility when inheriting retirement accounts:

• Spousal rollover: A spouse can roll the inherited account into their own IRA. This delays RMDs until they reach age 73 and allows designation of new beneficiaries. This option is usually best if the surviving spouse is younger than the deceased or doesn’t need immediate income.

• Inherit as a beneficiary: The spouse keeps the account as an inherited IRA. They can take distributions based on their life expectancy or wait until the deceased spouse would have turned 73. This is useful if the surviving spouse is younger than 59½ and needs income; distributions avoid the 10% early withdrawal penalty.

• Lump‑sum distribution: The spouse takes all assets immediately, paying income tax on the distribution. This is generally not recommended unless funds are needed right away.

Spouses should evaluate which option meets their financial needs and tax situation.

Planning for Non‑Spouse Beneficiaries

Non‑spouse beneficiaries don’t have the same flexibility. Under the SECURE Act, most must empty the account within 10 years. Strategies include:

• Roth conversions: Converting a traditional IRA to a Roth IRA before death shifts tax liability to you. Beneficiaries then receive tax‑free distributions within the 10‑year period.

• Charitable bequests: Designating a charity as beneficiary avoids income tax on retirement assets. Leave other assets (with a stepped‑up basis) to individuals.

• Stretching for eligible beneficiaries: For a minor child, consider leaving the account directly (or via a conduit trust) so distributions can be stretched until age of majority, then follow the 10‑year rule.

• Divide accounts: If you have multiple beneficiaries with different tax situations, consider splitting the account after death (or leaving separate accounts) so each beneficiary can plan distributions independently.

Coordinating Retirement Accounts with Your Estate Plan

1. Review beneficiary designations regularly. Coordinate them with your will or trust to ensure a unified plan.

2. Incorporate retirement assets into tax planning. Discuss with your advisor whether to leave retirement accounts to charitable beneficiaries, convert to Roth, or offset taxes with other deductions.

3. Consider a disclaimer. A beneficiary can decline all or part of an inherited account within nine months of the owner’s death, allowing the asset to pass to contingent beneficiaries or a trust. Disclaimers can direct assets in a more tax‑efficient way, but require careful planning.

4. Address community property or marital property laws. In community property states, a spouse may need to consent if the account was funded with marital assets. Plan accordingly.

5. Use trusts appropriately. When control or protection is needed, name a qualifying trust as beneficiary. Ensure the trust language complies with IRS requirements for see‑through trusts.

Example Scenarios

Scenario 1: Leaving an IRA to a minor child: Laura wants her 12‑year‑old daughter, Chloe, to inherit her IRA. Rather than name Chloe outright, Laura names a conduit trust as the beneficiary. The trust provides for distributions for Chloe’s health, education, maintenance, and support. The trustee distributes the required RMDs annually, which pass directly to Chloe. When Chloe turns 18 (age of majority in her state), the 10‑year rule begins. The trustee ensures any remaining balance is distributed by year 10, providing financial support into Chloe’s twenties.

Scenario 2: Blended family: David has grown children from a first marriage and a second wife, Mia. David’s largest asset is his 401(k). He names Mia as primary beneficiary and his children as contingent beneficiaries. At David’s death, Mia rolls the 401(k) into her own IRA. She names David’s children as beneficiaries of her IRA to ensure they eventually inherit. Alternatively, David might leave the 401(k) to a trust that pays income to Mia for life and principal to his children after Mia’s death, balancing both interests.

Scenario 3: Roth conversion for tax efficiency: Henry, age 65, has a sizable traditional IRA and two adult children in high tax brackets. Henry anticipates higher tax rates in the future and wants to minimize his children’s tax burden. Over several years, Henry converts portions of his traditional IRA to a Roth IRA, paying taxes at current rates. When Henry dies, his children inherit the Roth IRA and must withdraw it within 10 years, but distributions are tax‑free, preserving more wealth.

Frequently Asked Questions

Do I need to include retirement accounts in my will? Your will does not control your retirement accounts if you have named beneficiaries. You should still mention the existence of these accounts in your estate planning documents and coordinate with beneficiary designations.

Can I name my estate as the beneficiary? While you can, it’s usually not advisable. The account will be subject to probate and may have to be distributed more quickly, increasing taxes. It also exposes the account to your estate’s creditors.

What happens if I get divorced? Divorce decrees may override beneficiary designations for retirement accounts if governed by ERISA (such as a 401(k)). Always update beneficiary forms after a divorce and ensure the settlement addresses retirement accounts. Some states automatically revoke a spouse as beneficiary, but federal law may pre‑empt state law for employer plans.

Can I split an IRA among multiple beneficiaries? Yes. You can name multiple beneficiaries and assign percentages. After your death, the IRA can be split into separate accounts so each beneficiary can manage distributions independently.

Should I convert my traditional IRA to a Roth? A Roth conversion can benefit heirs by providing tax‑free distributions, particularly under the 10‑year rule. However, you must pay income tax on the converted amount now. Consult a tax advisor to determine if the upfront cost is worth the long‑term benefit.

Conclusion

Retirement accounts require special attention in estate planning. Because beneficiary designations control their disposition and tax rules are complex, coordination with your overall plan is essential. Regularly review beneficiary forms, understand the implications of the SECURE Act’s 10‑year rule, consider whether trusts are needed for control and protection, and explore strategies like Roth conversions and charitable bequests. Working with an estate planning attorney and tax advisor will help you develop a plan that honors your wishes, minimizes taxes, and provides financial security for your loved ones.