Life is unpredictable. You plan for retirement while working to have an income and financial security during your golden years. That can be done with a pension plan, a 401(k) account, or an IRA. Building those retirement savings can take decades. But what happens if you pass before you can spend it all? We’ll answer that in this article.
Defined Contribution Retirement Plans
A defined contribution retirement plan is established by your employer to be used as a vehicle for retirement savings. Two common examples of this are a 401(k) plan for private industry employees and 403(b)s in the public sector. You can make tax-deferred contributions of up to $22,500 per year, and your employer may or may not match those contributions.
Retirement plan administrators typically ask you to assign a beneficiary when opening your account. Your beneficiary could be a spouse, an adult child, or a family member. If you’re single with no children, you could choose someone outside your family, but you’ll need their social security number and personal information to complete the beneficiary sign-up form.
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Assigning a beneficiary simplifies the transfer of your retirement savings. Your beneficiary can cash out your savings, take over the plan as their own, or roll it into their existing retirement savings account. Without a beneficiary, your retirement savings will be absorbed into your estate to go through the probate process before being distributed.
Traditional IRAs and Roth IRAs
Making your spouse the beneficiary of your IRA ensures they’ll receive those funds when you’re no longer with them. They can roll it over, treat it as their own, or cash out the account. They also inherit the tax liability or early withdrawal penalties on those accounts if they make them their own and have not reached age 59 ½. Here’s a quick breakdown of those rules:
- Contributions to traditional IRAs are tax-deferred, so taxes must be paid when you (or your spouse) take distributions.
- Contributions to a Roth IRA are made with after-tax income. Distributions are tax-free.
- Cashing out an IRA before the account holder passes the age of 59 ½ will incur a 10% early withdrawal penalty.
Once the IRA has been claimed or rolled over, your beneficiary can continue to contribute up to $6,500 per year ($7,500 if they’re over 50 years old). Non-spouse beneficiaries do not have the option of rolling over the account. They can either wait and take the distributions when available or cash out the IRA and pay the penalty.
Pension Plans
The IRS has a different classification for pension plans. They’re known as “defined benefits retirement plans” because the pension holder’s contributions do not determine their payout in retirement. Pensions are an agreement between the employer and employee that a specific amount will be paid to the employee after retirement, based on their years of employment.
Since pensions are essentially a contract, there’s no guarantee that a surviving spouse or family member will continue to get paid after you die. That, combined with the higher maintenance costs and fees, has led to a decline in the popularity of pensions. Check the terms and conditions if you have a pension through your job. Pay particular attention to “survivor benefits.”
The Bottom Line
If you haven’t done so, assign a beneficiary to your retirement savings. This person can be your spouse, adult child, or other family member. Make sure they understand the tax liabilities and early withdrawal penalties so your loved ones are prepared if you perish before them. If you have a pension plan, check the details of the survivor benefits. Speak with your financial advisor for alternative retirement options if your contract doesn’t provide them.
Sources:
https://www.debt.org/retirement/accounts-after-death/
https://meetbeagle.com/resources/post/what-happens-to-your-401-k-when-you-die
https://www.bankrate.com/retirement/inherited-ira-rules/
https://finance.yahoo.com/news/happens-pension-die-140026425.html
