If you are like most Americans, by the time you approach or reach retirement age, your two biggest assets are your home and your retirement account. If you are in the process of creating an estate plan, or are beginning to think about it, you may be asking yourself, “what happens to my retirement when I die?” Good question and, as with most questions posed on this site, the answer is “it depends.”
Traditional Pension Plans (Defined Benefit Plans)
If you receive a defined benefit plan through your employer (what’s typically called a pension) then your retirement payments will generally stop upon your death. A portion of your payments may continue to go to a surviving spouse, depending on your plan or elections you made under it.
IRAs and 401(k)s
What happens to your retirement after you die is a little more complex if your retirement funds are in an IRA or 401(k) (or 403(b) if you are an educator or work in the non-profit world). Generally, the funds in the IRA or 401(k) will go to the person you have listed as your beneficiary with the financial institution or plan administrator. If you have no beneficiary listed, or if your beneficiary dies before you, then the funds in the account will go to your estate and, after probate, will pass to your heirs or to the beneficiaries listed in your Will.
Tax Consequences for IRAs and 401(k)s
Okay, so who gets your retirement after you die is simple enough – the person or persons you list on your beneficiary forms (and please be sure to have living beneficiaries listed). The confusion usually comes with how the funds are received. Remember the advantage of a traditional IRA and a 401(k) is that taxes on funds put into the accounts are deferred. Note: taxes are deferred NOT done away with. When you retire and begin withdrawing funds from an IRA or 401(k) the funds that you withdraw are taxed at that time. The same is true for your beneficiaries. They are taxed on your IRA or 401(k) funds when the funds are withdrawn from the accounts and passed to your beneficiaries (exception – a surviving spouse can roll over the deceased spouse’s plan into his or her own retirement account to continue the tax deferment).
Funds withdrawn from IRAs and 401(k)s are treated and taxed as income. As with any income, the amount received in any given year determines your tax bracket and thus, the amount of taxes you have to pay. It is therefore beneficial (from a tax standpoint) to stretch out the withdrawals from an IRA or 401(k) over as many years as possible. In next week’s article I will discuss the time periods allowed for withdrawals of IRA and 401(k) funds under different scenarios.
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