401k beneficiary - whether or not to designate

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oldcomputerguy
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401k beneficiary - whether or not to designate

Post by oldcomputerguy » Mon Oct 30, 2017 3:26 pm

DW has designated her niece (who is also our will executrix) as a contingent beneficiary on her 401k account. I initially thought this was a good idea. However, I've recently had second thoughts.

According to what I've read, if DW and I both die in common demise (say, in a plane crash, car wreck, or other disaster), then with this beneficiary designation, her 401k goes to the niece without having to go through probate. (The niece would then divide it up among the other heirs designated in the will.) The niece has a Roth IRA but not a traditional, so such a roll-over will involve a huge tax hit whether she takes the lump sum or a roll-over. And, of course, she might have problems pulling the roll-over from a Roth IRA and distributing it per our wishes.

However, if we remove the beneficiary designation, then in case of our common demise, the 401k becomes part of the estate, and ultimately will be divided up among the heirs. Our state does not have an inheritance tax, and the total value of our estate will be less than the federal estate tax exemption, so putting the 401k through probate as part of the estate would seem to be better for the neice (and the heirs) from a tax standpoint.

Other than the added expense and time of the probate proceeding, what am I missing?
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TheAncientOne
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Re: 401k beneficiary - whether or not to designate

Post by TheAncientOne » Mon Oct 30, 2017 3:33 pm

The beneficiary designation of a tax sheltered account (same for life insurance as well) overrules whatever your will or trust says. In the example you give, the niece would be recipient of your 401k funds and would be seen as gifting what is now her money. Is your 401k large enough that you will be creating an estate/gift tax problem for her?

As a practical matter lots of estates, maybe a majority, are settled without regard to wills or legal niceties but if you're talking lots of money, I'd list all of the intended recipients as beneficiaries of the account.

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dm200
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Re: 401k beneficiary - whether or not to designate

Post by dm200 » Mon Oct 30, 2017 3:39 pm

oldcomputerguy wrote:
Mon Oct 30, 2017 3:26 pm
DW has designated her niece (who is also our will executrix) as a contingent beneficiary on her 401k account. I initially thought this was a good idea. However, I've recently had second thoughts.
According to what I've read, if DW and I both die in common demise (say, in a plane crash, car wreck, or other disaster), then with this beneficiary designation, her 401k goes to the niece without having to go through probate. (The niece would then divide it up among the other heirs designated in the will.) The niece has a Roth IRA but not a traditional, so such a roll-over will involve a huge tax hit whether she takes the lump sum or a roll-over. And, of course, she might have problems pulling the roll-over from a Roth IRA and distributing it per our wishes.
However, if we remove the beneficiary designation, then in case of our common demise, the 401k becomes part of the estate, and ultimately will be divided up among the heirs. Our state does not have an inheritance tax, and the total value of our estate will be less than the federal estate tax exemption, so putting the 401k through probate as part of the estate would seem to be better for the neice (and the heirs) from a tax standpoint.
Other than the added expense and time of the probate proceeding, what am I missing?
1. Common disaster seems not the issue. The issue is if you predecease your wife - then she dies - it would go to the neice without going through probate. Is that what your wife wants?

2. Why would the neice divide it up to anyone else? If the neice is the beneficiary, then the will is irrelevant and she would/could keep the whole thing. Just my opinion, but the tax aspects seem the least relevant - while getting the money solidly to all of the intended folks is the most relevant. After all, the recipients can pay income tax from the gross amount received. Without being in the will and diretly named, there is no way that your wife can be assured the funds get where intended.

3. If this were me or my wife, I would not tell the neice or other similar beneficiaries that they are named. The possibility of getting money is somewhat remote and you can always change your mind.

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tarnation
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Re: 401k beneficiary - whether or not to designate

Post by tarnation » Mon Oct 30, 2017 4:07 pm

oldcomputerguy wrote:
Mon Oct 30, 2017 3:26 pm
DW has designated her niece (who is also our will executrix) as a contingent beneficiary on her 401k account. I initially thought this was a good idea. However, I've recently had second thoughts.

According to what I've read, if DW and I both die in common demise (say, in a plane crash, car wreck, or other disaster), then with this beneficiary designation, her 401k goes to the niece without having to go through probate. (The niece would then divide it up among the other heirs designated in the will.) The niece has a Roth IRA but not a traditional, so such a roll-over will involve a huge tax hit whether she takes the lump sum or a roll-over. And, of course, she might have problems pulling the roll-over from a Roth IRA and distributing it per our wishes.

However, if we remove the beneficiary designation, then in case of our common demise, the 401k becomes part of the estate, and ultimately will be divided up among the heirs. Our state does not have an inheritance tax, and the total value of our estate will be less than the federal estate tax exemption, so putting the 401k through probate as part of the estate would seem to be better for the neice (and the heirs) from a tax standpoint.

Other than the added expense and time of the probate proceeding, what am I missing?
What you have outlined will not work and I recall there is a Five-year rule to watch out for if you make the estate the beneficiary. I think what you are looking for is to name all beneficiaries on the beneficiary designation. Then they can all roll to inherited IRA's and have RMD based on their individual ages.
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Re: 401k beneficiary - whether or not to designate

Post by oldcomputerguy » Mon Oct 30, 2017 4:29 pm

dm200 wrote:
Mon Oct 30, 2017 3:39 pm
1. Common disaster seems not the issue. The issue is if you predecease your wife - then she dies - it would go to the neice without going through probate. Is that what your wife wants?
I think she designated the niece because the niece is already the executor, and perhaps my wife's favorite relative. She didn't plan for the entire 401k to go to the niece, rather to be divided between the named beneficiaries.
2. Why would the neice divide it up to anyone else?
That is our express wish. Given that, perhaps the beneficiary mechanism is not the correct vehicle to carry that out?

After all, the recipients can pay income tax from the gross amount received.[/quote]

Yes, they can. But with the infux of the inheritance (assuming dollar amounts where they stand today), I was hoping to avoid kicking the niece (or any of the heirs, for that matter) up into a higher tax bracket, which would not only make for a higher tax hit on the inheritance but also cause their regular earnings from their employment to be taxed at a higher rate.
3. If this were me or my wife, I would not tell the neice or other similar beneficiaries that they are named.
She is not aware of the beneficiary designation. Being the executor, and having a copy of both our wills, she of course knows about being named an inheritor.
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Earl Lemongrab
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Re: 401k beneficiary - whether or not to designate

Post by Earl Lemongrab » Mon Oct 30, 2017 4:31 pm

If the niece is the only beneficiary, then the money is completely hers and she can do what she wishes with it. Dividing it up would entail withdrawing part from the account, paying taxes, and making gifts. It would not be part of the estate. If it's to be divided up, make all of them contingent beneficiaries if the plan allows.
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Re: 401k beneficiary - whether or not to designate

Post by oldcomputerguy » Mon Oct 30, 2017 4:38 pm

tarnation wrote:
Mon Oct 30, 2017 4:07 pm

What you have outlined will not work and I recall there is a Five-year rule to watch out for if you make the estate the beneficiary. I think what you are looking for is to name all beneficiaries on the beneficiary designation. Then they can all roll to inherited IRA's and have RMD based on their individual ages.
According to the plan documents, the choices available if the beneficiary is not a spouse are two: either a lump-sum distribution or a roll-over to an IRA.

Earl L: The niece is the only beneficiary set up on DW's 401k. There are multiple heirs (of which the niece is one) named in the will.

The issue isn't one of trusting the niece; she's going to divide up what remains of our estate regardless. My only concern was whether we were doing damage to her on a tax front by naming her as the beneficiary to the 401k. But if the 401k is not part of the estate, then how does one get divided up after the owner's death, assuming the owner does not name a beneficiary?

Sounds given the above like the best option would be to do as is suggested here, namely to set up designations for all the desired beneficiaries and let them roll over individually. I was just trying to eliminate a large tax hit for them.
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Re: 401k beneficiary - whether or not to designate

Post by tarnation » Mon Oct 30, 2017 4:56 pm

oldcomputerguy wrote:
Mon Oct 30, 2017 4:38 pm
tarnation wrote:
Mon Oct 30, 2017 4:07 pm

What you have outlined will not work and I recall there is a Five-year rule to watch out for if you make the estate the beneficiary. I think what you are looking for is to name all beneficiaries on the beneficiary designation. Then they can all roll to inherited IRA's and have RMD based on their individual ages.
Sounds given the above like the best option would be to do as is suggested here, namely to set up designations for all the desired beneficiaries and let them roll over individually. I was just trying to eliminate a large tax hit for them.
^ that is the smallest tax hit. They will only pay tax as they withdraw it and only have to withdraw RMD's. The other way where you designate one person is worst. The only way for her to divide it is to withdraw (and pay tax) and then gift it to the other indented bene's. Which depending on the amounts, would probably be above annual gift exclusion threshold. The makings of a real mess.
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Re: 401k beneficiary - whether or not to designate

Post by LK2012 » Mon Oct 30, 2017 5:05 pm

tarnation wrote:
Mon Oct 30, 2017 4:56 pm
oldcomputerguy wrote:
Mon Oct 30, 2017 4:38 pm
tarnation wrote:
Mon Oct 30, 2017 4:07 pm

What you have outlined will not work and I recall there is a Five-year rule to watch out for if you make the estate the beneficiary. I think what you are looking for is to name all beneficiaries on the beneficiary designation. Then they can all roll to inherited IRA's and have RMD based on their individual ages.
Sounds given the above like the best option would be to do as is suggested here, namely to set up designations for all the desired beneficiaries and let them roll over individually. I was just trying to eliminate a large tax hit for them.
^ that is the smallest tax hit. They will only pay tax as they withdraw it and only have to withdraw RMD's. The other way where you designate one person is worst. The only way for her to divide it is to withdraw (and pay tax) and then gift it to the other indented bene's. Which depending on the amounts, would probably be above annual gift exclusion threshold. The makings of a real mess.
Yes, leaving it all to the niece and having her distribute money to others, will result in unnecessary taxes - especially if you expect her to do it all at once - and a rather messy situation for her in any case.

Leaving no beneficiary, I believe, could dump the 401(k) into the estate, and thereby remove its tax protection all at once. Please don't do that.

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Earl Lemongrab
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Re: 401k beneficiary - whether or not to designate

Post by Earl Lemongrab » Mon Oct 30, 2017 5:09 pm

oldcomputerguy wrote:
Mon Oct 30, 2017 4:38 pm

Earl L: The niece is the only beneficiary set up on DW's 401k. There are multiple heirs (of which the niece is one) named in the will.
A will has nothing to do with assets passed this way.
The issue isn't one of trusting the niece; she's going to divide up what remains of our estate regardless. My only concern was whether we were doing damage to her on a tax front by naming her as the beneficiary to the 401k. But if the 401k is not part of the estate, then how does one get divided up after the owner's death, assuming the owner does not name a beneficiary?
It doesn't even have to be intentional. She could inherit, transfer the money to an IRA, then die herself.

If there is no beneficiary, then it's part of the estate and goes through probate.
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Re: 401k beneficiary - whether or not to designate

Post by vaught » Mon Oct 30, 2017 5:23 pm

oldcomputerguy wrote:
Mon Oct 30, 2017 3:26 pm
DW has designated her niece (who is also our will executrix) as a contingent beneficiary on her 401k account. I initially thought this was a good idea. However, I've recently had second thoughts.

According to what I've read, if DW and I both die in common demise (say, in a plane crash, car wreck, or other disaster), then with this beneficiary designation, her 401k goes to the niece without having to go through probate. (The niece would then divide it up among the other heirs designated in the will.) The niece has a Roth IRA but not a traditional, so such a roll-over will involve a huge tax hit whether she takes the lump sum or a roll-over. And, of course, she might have problems pulling the roll-over from a Roth IRA and distributing it per our wishes.

However, if we remove the beneficiary designation, then in case of our common demise, the 401k becomes part of the estate, and ultimately will be divided up among the heirs. Our state does not have an inheritance tax, and the total value of our estate will be less than the federal estate tax exemption, so putting the 401k through probate as part of the estate would seem to be better for the neice (and the heirs) from a tax standpoint.

Other than the added expense and time of the probate proceeding, what am I missing?
You are misconstruing that your 401k is part of your estate. The way you have the beneficiary designation, that amount will be distributed outside of your estate. This is a very common misconception.

In the current scenario, if your wife pre-deceases you, your entire 401k balance will be distributed to your niece as contingent beneficiary at your death. Your 401k provider will not even ask to look at your will. It is a contractual provision that they are obligated to pay the beneficiary designated.

The same applies for life insurance polices.

The only way that your 401k balance would be part of your estate would be if you named your estate as the beneficiary of your 401k. Then your 401k provider would make a check payable to your estate and only then would the wishes of your will apply as to who gets a portion of that balance.

I would advise seeking other input as to the pros and cons of that strategy.

If you know that you want your niece as executrix to distribute your 401k to A, B, and C, then why not just put A, B and C as your contingent beneficiaries?

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Re: 401k beneficiary - whether or not to designate

Post by oldcomputerguy » Mon Oct 30, 2017 5:28 pm

vaught wrote:
Mon Oct 30, 2017 5:23 pm
If you know that you want your niece as executrix to distribute your 401k to A, B, and C, then why not just put A, B and C as your contingent beneficiaries?
Based on the good advice here, I think that's exactly what we'll do.
(Sure glad I asked, and thanks everyone for the responses.)
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Re: 401k beneficiary - whether or not to designate

Post by tuningfork » Mon Oct 30, 2017 7:33 pm

oldcomputerguy wrote:
Mon Oct 30, 2017 5:28 pm
vaught wrote:
Mon Oct 30, 2017 5:23 pm
If you know that you want your niece as executrix to distribute your 401k to A, B, and C, then why not just put A, B and C as your contingent beneficiaries?
Based on the good advice here, I think that's exactly what we'll do.
(Sure glad I asked, and thanks everyone for the responses.)
Not quite. Specify the niece and A, B, and C all *primary* beneficiaries. If you make some of them contingent beneficiaries, they only get the money if none of the primaries are alive at the time of your death.

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oldcomputerguy
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Re: 401k beneficiary - whether or not to designate

Post by oldcomputerguy » Mon Oct 30, 2017 8:09 pm

tuningfork wrote:
Mon Oct 30, 2017 7:33 pm
oldcomputerguy wrote:
Mon Oct 30, 2017 5:28 pm
vaught wrote:
Mon Oct 30, 2017 5:23 pm
If you know that you want your niece as executrix to distribute your 401k to A, B, and C, then why not just put A, B and C as your contingent beneficiaries?
Based on the good advice here, I think that's exactly what we'll do.
(Sure glad I asked, and thanks everyone for the responses.)
Not quite. Specify the niece and A, B, and C all *primary* beneficiaries. If you make some of them contingent beneficiaries, they only get the money if none of the primaries are alive at the time of your death.
Thing is, Schwab considers *me* (the spouse) to be the “primary”beneficiary.
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tuningfork
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Re: 401k beneficiary - whether or not to designate

Post by tuningfork » Mon Oct 30, 2017 8:23 pm

oldcomputerguy wrote:
Mon Oct 30, 2017 8:09 pm
Thing is, Schwab considers *me* (the spouse) to be the “primary”beneficiary.
OK, now I see. Yep, you're the primary, make all the others contingents. Sorry for any confusion.

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