Retirement accounts often represent a substantial portion of a family’s wealth. Unlike many other assets, however, retirement accounts generally pass according to beneficiary designations rather than according to the terms of a Will or revocable trust.

This makes beneficiary designations a critical part of any estate plan. An outdated beneficiary designation can result in retirement assets passing to someone other than the person the account owner currently intends to benefit.

Beneficiary designations should therefore be reviewed as part of the overall estate plan and updated after major life events, changes in tax law, and significant changes to the estate plan.

Why Beneficiary Designations Matter

A common estate-planning mistake is assuming that a Will or revocable trust determines who inherits an IRA, 401(k), or other retirement account. Generally, it does not.

Instead, retirement accounts typically pass according to the beneficiary designation maintained by the account custodian or plan administrator.

For example, an account owner may have:

• Divorced and remarried.
• Had a child or adopted a child.
• Established or amended a revocable trust.
• Changed the terms of a Will.
• Had a previously designated beneficiary die.
• Experienced a significant change in family or financial circumstances.

If the beneficiary designation on the retirement account was never updated, the account may pass according to an outdated designation even though the owner's broader estate plan has changed.

When Should Beneficiary Designations Be Reviewed?

Beneficiary designations should generally be reviewed after major life events, including:

• Marriage.
• Divorce.
• Birth or adoption of a child.
• Death of a beneficiary.
• Establishment or amendment of a trust.
• A significant change to a Will or other estate-planning document.
• A substantial change in financial circumstances.
• Changes in applicable retirement-account or tax laws.

Beneficiary designations should also be reviewed periodically, even when no major life event has occurred.

Understanding the Major Types of Retirement Accounts

Different retirement accounts have different contribution, distribution, and tax rules. Those differences can affect estate-planning decisions and the consequences of naming a particular beneficiary.

Traditional IRA

Traditional IRA contributions may be deductible depending on the account owner's circumstances. Investment earnings generally grow tax-deferred, and distributions are generally subject to ordinary income tax.

Because inherited traditional IRA distributions can generate taxable income for the beneficiary, the identity of the beneficiary and the timing of distributions can have significant income-tax consequences.

Roth IRA

Roth IRA contributions are made with after-tax dollars. Qualified distributions are generally tax-free.

Roth IRAs can be particularly valuable estate-planning assets because the original owner is not subject to lifetime required minimum distributions (RMDs) under current federal law.

The tax-free nature of qualified Roth IRA distributions can also make the Roth IRA an attractive asset to leave to certain beneficiaries, although inherited Roth IRAs remain subject to applicable beneficiary distribution rules.

401(k) and 403(b) Plans

401(k) and 403(b) plans are employer-sponsored retirement plans. They generally allow pretax contributions and tax-deferred growth, and many plans also offer Roth contribution options.

Beneficiary rules can vary by plan. The plan document and beneficiary designation should therefore be reviewed before making or changing a designation.

SEP IRA

A SEP IRA is commonly used by self-employed individuals and small-business owners. Contributions are generally made by an employer and grow tax-deferred.

The appropriate beneficiary depends on the account owner's family circumstances, estate plan, and tax-planning objectives.

SIMPLE IRA

A SIMPLE IRA is designed primarily for small businesses and generally permits employees and employers to make contributions on a pretax basis.

As with other retirement accounts, beneficiary designations should be coordinated with the owner's overall estate plan.

How the SECURE Act Changed Inherited Retirement Accounts

The SECURE Act of 2019, together with subsequent legislation and regulatory guidance, significantly changed the rules governing inherited retirement accounts.

One of the most important changes involved the elimination of the traditional "stretch IRA" strategy for many non-spouse beneficiaries.

The 10-Year Rule

For many beneficiaries who inherit retirement accounts after 2019, the account generally must be completely distributed by the end of the 10th year following the account owner's death.

The 10-year rule does not apply in exactly the same way to every beneficiary. Certain individuals qualify as Eligible Designated Beneficiaries (EDBs) and may receive more favorable distribution treatment.

Common categories of EDBs include:

• A surviving spouse.
• A minor child of the account owner.
• A disabled beneficiary.
• A chronically ill beneficiary.
• Certain beneficiaries who are not more than 10 years youngerthan the account owner.

The precise requirements for EDB status should be reviewed because the rules differ depending on the beneficiary's circumstances.

Why the 10-Year Rule Matters

The 10-year rule can create significant income-tax planning opportunities and challenges.

For example, a beneficiary who inherits a large traditional IRA could potentially increase taxable income substantially by taking a large distribution in a single year. Depending on the beneficiary's circumstances,spreading distributions over multiple years may help manage the resulting income-tax liability.

However, beneficiaries should not automatically assume that they can leave the entire inherited account untouched until the end of the tenth year.

Depending on the circumstances, annual distribution requirements may apply during the 10-year period, particularly when the original account owner had already reached the applicable required beginning date for RMDs.

Eligible Designated Beneficiaries

An Eligible Designated Beneficiary may qualify for distribution treatment that differs from the standard rules applicable to many other beneficiaries.

For example, a surviving spouse may have the ability to treat an inherited retirement account as the spouse's own IRA, subject to applicable rules. A minor child may qualify for EDB treatment while the child remains a minor under the applicable federal rules.

Importantly, a child does not necessarily retain EDB treatment indefinitely. Once the child reaches the applicable age of majority, the remaining account generally becomes subject to the 10-year rule.

Determining whether a beneficiary qualifies as an EDB can therefore materially affect both the timing of distributions and the taxation of inherited retirement assets.

Required Minimum Distributions

Required minimum distributions, or RMDs, are mandatory withdrawals from certain retirement accounts once the account owner reaches the applicable required beginning age.

Inherited retirement accounts have separate RMD rules. The applicable rules depend on several factors, including:

• The type of retirement account.
• Whether the original account owner had reached theapplicable required beginning date.
• Whether the beneficiary is an individual, trust, or othertype of beneficiary.
• Whether the beneficiary qualifies as an Eligible DesignatedBeneficiary.
• The date the account owner died.
• The applicable federal tax rules governing inheritedretirement accounts.

Surviving Spouses

A surviving spouse generally has more flexibility than many other beneficiaries.

Depending on the circumstances, a surviving spouse may be able to roll an inherited retirement account into the spouse's own IRA or otherwise elect treatment that provides greater flexibility.

Because the available options can affect both RMDs and income taxes, a surviving spouse should evaluate the available alternatives before automatically moving or distributing inherited retirement assets.

Beneficiaries Subject to the 10-Year Rule

For beneficiaries subject to the 10-year rule, additional annual distribution requirements may apply in certain circumstances.

As a result, beneficiaries should not assume that the entire inherited account can simply remain invested until the tenth year and then be distributed in one lump sum.

The applicable RMD rules should be determined before deciding when and how much to withdraw.

How Does a Revocable Trust Fit Into Retirement Planning?

A revocable living trust can be an important component of an estate plan. Depending on its terms and the family's circumstances, a trust can help:

• Avoid probate for assets properly transferred to the trust.
• Provide continuity of asset management.
• Establish rules for how inherited assets are managed anddistributed.
• Provide additional control over distributions.
• Protect assets for certain beneficiaries.

However, retirement accounts generally are not retitled into a revocable trust during the owner's lifetime in the same way as many other trust assets. Instead, the trust may be named as the retirement account beneficiary.

Naming a trust as the beneficiary of a retirement account can be beneficial in some circumstances, but it requires careful planning.

Trusts as Retirement-Account Beneficiaries

A properly drafted trust may qualify for special treatment under the federal retirement-account rules. These rules can allow the trust's underlying beneficiaries to be considered when determining the applicable distribution rules.

Trusts used in connection with retirement accounts are commonly discussed as either conduit trusts or accumulation trusts.

Conduit Trust

A conduit trust generally requires retirement-account distributions received by the trust to be distributed to the trust beneficiary.

This structure can provide a beneficiary with less control over the retirement account itself while potentially limiting the trust's ability to retain retirement-account distributions.

Accumulation Trust

An accumulation trust may permit retirement-account distributions to remain in the trust rather than requiring immediate distribution to the trust beneficiary.

This can provide greater control over how and when assets are distributed and may offer advantages in certain circumstances. However, accumulation trusts can also introduce additional tax, RMD, and administrative complexities.

Because the rules governing trusts and retirement accounts are technical, the trust document and retirement-account beneficiary designation should be reviewed together.

Who Should Be the Beneficiary of a Retirement Account?

There is no universal beneficiary designation that is appropriate for every family. The appropriate beneficiary depends on factors such as the account type, the beneficiary's age and circumstances, tax considerations, family structure, asset-protection concerns, and the overall estate plan.

A general framework is:

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These are general planning considerations, not universal recommendations. Beneficiary designations should be tailored to the account owner's circumstances and coordinated with the rest of the estate plan.

When Might a Trust Be the Better Choice?

Naming an individual beneficiary can be straightforward, but an outright inheritance is not necessarily appropriate for every beneficiary.

A trust may deserve special consideration when a beneficiary:

• Is a minor.
• Has a disability or special needs.
• Is financially inexperienced.
• May have difficulty managing a substantial inheritance.
• Is in a blended family.
• May be vulnerable to creditors or other financial risks.
• Needs long-term management or controlled distributions.
• Would benefit from professional or trustee oversight.

A properly structured trust can provide greater control over how inherited assets are managed and distributed. However, using a trust as the beneficiary of a retirement account requires careful coordination of the trust terms with the applicable retirement-account rules.

Coordinate Retirement Accounts With the Entire Estate Plan

Retirement-account planning is no longer simply a matter of naming a beneficiary and leaving the account untouched.

The SECURE Act and subsequent changes have made the interaction among retirement accounts, beneficiary designations, trusts, RMDs,and income taxes significantly more complex.

For many families, retirement-account beneficiary designations should be reviewed as part of the broader estate plan. This may include coordinating:

• Retirement-account beneficiary designations.
• Revocable trusts.
• Wills.
• Powers of attorney.
• Life insurance beneficiary designations.
• Tax-planning strategies.
• Family and business succession plans.

The goal is not simply to determine who inherits a retirement account, but also to determine how, when, and under what tax rules the inherited account will be distributed.

A beneficiary designation that was appropriate several years ago may no longer achieve the owner's current estate-planning objectives. Regularly reviewing these designations—and coordinating them with the broader estate plan—can help reduce the risk of unintended beneficiaries, unexpected tax consequences, and distribution problems.