Planning is even more crucial due to the special rules associated with retirement accounts, such as IRAs and 401(k)s.
Retirement assets generally transfer directly to properly designated beneficiaries without passing through probate. However, the downside is that these assets are often subject to federal and state income tax, as well as possible federal and state estate tax. To help reduce the burden, plan properly, utilize the deduction for federal estate taxes paid on these assets, and understand the required minimum distribution (RMD) rules.
Steps to help reduce taxes
Do retirement accounts pass through probate?
NO, as long as the beneficiaries are properly designated. Keep in mind that if the will stipulates anything about such accounts, the named beneficiaries take precedence over the will and the assets will be distributed to the named beneficiaries on the accounts.
YES, if there are no beneficiaries named on the account and if the plan documents or any associated IRA custodial agreements do not specifically address who would then be the beneficiary. For example, generally if all of the named beneficiaries have passed away first and the designation was never updated, the account will be subject to probate.
There are several things you can do in the estate planning process that may help reduce taxes on the retirement assets you pass on to your beneficiaries. Consult a tax advisor about your situation.
- Designate your beneficiaries carefully and review your designations before you’re required to begin taking distributions from your retirement plan accounts. Your choices may impact the RMD options from your accounts by your beneficiaries.
- Inform your beneficiaries that they may be able to take an income tax deduction for federal estate tax paid with respect to the retirement account; this can substantially reduce the income tax they will owe when they withdraw the assets.
- Consider an irrevocable life insurance trust (ILIT) to provide liquidity to pay the federal estate tax related to your retirement assets. This can help avoid leaving your beneficiaries in a position where they have to accelerate distributions to cover estate taxes.
- If you plan to leave some of your estate to charity, consider designating retirement plan assets for this purpose. These assets may escape both estate and income tax. Consider placing these assets in a separate retirement account to preserve payout options for your other retirement account beneficiaries.
- Make your beneficiaries aware that they will need to take RMDs. The rules can be complicated. A tax advisor can help explain the requirements to you and your beneficiaries.
There are also special provisions for surviving spouses in most retirement plans.
To learn about the options your beneficiaries will have when inheriting an IRA, see Fidelity Viewpoints® on Non-Spouse Inherited IRAs.
401(k)s and other defined-contribution plans
Although staying in plan may be desirable for your beneficiary, the plan's rules may require an immediate distribution. Your beneficiary may be able to stay in the plan and take distributions, or the plan may require an immediate distribution. If the plan requires an immediate distribution, your beneficiary can elect a direct trustee-to-trustee transfer to an inherited IRA at the financial institution of their choosing. If your beneficiary is your spouse, in addition to the option mentioned above, your spouse may be able to transfer the inherited benefit to their own employer sponsored plan or to their own IRA. The plans follow roughly the same guidelines for what is taxable as IRAs, but other features may vary. It's a good idea to have your beneficiary know what options they have under the plan.
Considerations if creditor protection is of concern
If creditor protection issues are a concern to you, the U.S. Supreme Court has opined that an inherited IRA is not eligible for bankruptcy protection (unless there is a separate state law providing such protection). This decision highlights the importance of beneficiary designations for each of your retirement accounts. For situations where creditor protection is of paramount concern and ERISA protection is not available, the use of trusts as beneficiaries may grow in popularity. Regardless, discussing this in advance with your attorney or tax advisor may help you to avoid any unintended consequences.
FAQs
YES, if there are no TOD beneficiaries named on the account or if there is a complication with the named beneficiary. For example, if the named beneficiary has passed away first and the designation was never updated, the account will be subject to probate.
What happens to Fidelity account when someone dies? ›
When you die, your 401(k) or Roth 401(k) generally passes to the beneficiaries listed on your plan. These are people you've told your plan administrator should receive the assets in your account upon your death.
What happens to retirement accounts when someone dies? ›
When a participant in a retirement plan dies, benefits the participant would have been entitled to are usually paid to the participant's designated beneficiary in a form provided by the terms of the plan (lump-sum distribution or an annuity).
What is the disadvantage of TOD? ›
A TOD doesn't provide creditor protection for the beneficiaries the way a formal trust does, and most financial institutions don't allow TODs to name formal trusts as their beneficiaries. The institutions allow only individuals as beneficiaries of TODs. For asset protection, you might want to create a formal trust.
Is transfer on death a good idea? ›
There seems to be a common misconception that adding a Transfer on Death (TOD) designation (also known as a beneficiary designation) to assets will cure all concerns at death. For the majority of families, this is not an accurate belief. While a TOD may avoid Probate, it does not solve all family concerns at death.
What is the difference between a transfer on death and a beneficiary? ›
Similar to when you leave assets in a will, transfer on death doesn't establish any rights until after you die. While you live, the named beneficiaries can't access or control the accounts. A TOD account also skips the probate process and takes precedence over a will.
Is a transfer on death account a retirement account? ›
The account owner specifies the percentage of assets each beneficiary receives, allowing their executor to distribute without first passing through probate. TOD cannot be used for retirement accounts like IRAs because retirement account beneficiaries must follow withdrawal and taxation rules.
Do Fidelity accounts go through probate? ›
Do assets with beneficiaries go through probate? Accounts or assets with named beneficiaries usually won't go through probate, including most assets held in trusts. This includes assets, such as investment accounts with transfer on death (TOD) designations and retirement accounts (IRAs and workplace accounts).
Do beneficiaries pay taxes on retirement accounts? ›
The main thing to remember about inheriting a traditional IRA is that distributions are generally taxable at the beneficiary's ordinary tax rate. If you inherit an IRA and take money out of it, you'll pay income taxes on it.
Who gets the $250 social security death benefit? ›
Program Description. Are you the surviving spouse or caregiver for the child of a worker who died? If so, you or the child(ren) may be eligible to get a lump-sum death payment of $255.
Some retirement plans require specific beneficiaries under the terms of the plan (such as a spouse or child). Beneficiaries of an IRA, and most plans, have the option of taking a lump-sum distribution of the inherited account at any time.
Can creditors go after retirement accounts after death? ›
Because retirement accounts with named beneficiaries are non-probate assets, such accounts avoid the reach of the decedent's creditors. If a retirement account never becomes part of the probate estate, it cannot be used to pay the decedent's final bills.
Does a TOD avoid capital gains tax? ›
A transfer on death (TOD) bank account is a popular estate planning tool designed to avoid probate court by naming a beneficiary. However, it doesn't avoid taxes.
Are TOD accounts a good idea? ›
For those who care about avoiding probate, ease of distribution to beneficiaries, and simplicity of set-up, a transfer on death (TOD) account could be a great option. A TOD account provides a simple way to transfer assets to beneficiaries without the need for complex legal structures like trusts.
Is money from a TOD account taxable? ›
Despite the convenience of avoiding probate, a TOD account does not inherently provide tax benefits or protections against estate or inheritance taxes. Upon your death, estate taxes may apply if the total value of your estate exceeds the federal exemption threshold, which is $13.61 million in 2024.
Can investments be transferred on death? ›
Grant of Probate is the legal right to deal with someone's property, money, investments and possessions (their 'estate') when they die. Companies will often need to see proof of this before they distribute any assets.
Can you transfer stock upon death? ›
Yes. The process for transferring stock ownership after death depends on whether the shares were held in a solely or jointly owned brokerage account. The easiest way to transfer stocks in an account with no co-owner is through a transfer-on-death beneficiary designation.
Can shares of a deceased person be transferred? ›
Taking this agreed upon statement to the court for approval is necessary for the successful transmission of shares to the heirs of the deceased account holder. Each legal heir will individually have to present their legal affidavit to the court for approval.
Is a tod considered an inheritance? ›
While a transfer on death designation can help avoid the probate process, the assets are still subject to applicable estate taxes, capital gains taxes, and inheritance taxes.
