Daily Progress, Jacksonville, TX


September 19, 2011

Money talk with Matt Montgomery

JACKSONVILLE — Editor’s note: Jacksonville Daily Progress financial columnist Matt Montgomery will begin appearing in the Living section the first Sunday of each month beginning in October. The following is his September column.

Selecting beneficiaries for retirement benefits is different from choosing beneficiaries for life insurance. While life insurance death benefits are not subject to federal income taxes, inherited retirement plans still carry their taxation provisions with them. Although taxes shouldn't be the sole determining factor in naming your beneficiaries, ignoring the impact of taxes could lead you to make an incorrect choice. In addition, if you're married, beneficiary designations may affect the size of minimum required distributions to you from your IRAs and retirement plans while you're alive.

Most inherited assets such as bank accounts, stocks, and real estate pass to your beneficiaries without income tax being due. However, the beneficiaries of 401(k) plans and IRAs will have to eventually pay ordinary income tax on distributions from them. However, Roth IRAs and Roth 401(k) will not cause your beneficiaries to owe any federal income taxes as long as all qualifications are met.

When it comes to income taxes, your spouse is usually the best choice for your primary beneficiary. A spousal beneficiary has the greatest flexibility for delaying distributions that are subject to income tax. In addition to rolling over your 401(k) or IRA to his or her IRA, a surviving spouse can generally decide to treat your IRA as his or her own IRA. This can provide more tax and planning options.

If you don’t have a spouse and you wish to name a child as primary beneficiary, there are different rules for children than spousal rules. For example, if one of your children inherits $100,000 cash from you and another child receives your 401(k) account worth $100,000, they aren't receiving the same amount. The reason is that all distributions from the 401(k) plan will be subject to income tax at the ordinary income tax rate of that child, while the cash isn't subject to income tax when it passes to the other child upon your death because that child gets what is known as a “step-up” in basis. Similarly, if one of your children inherits your taxable traditional IRA and another child receives your income-tax-free Roth IRA, the bottom line is different for each of them.

You can also name more than one individual as the primary beneficiary for your retirement benefits. You just need to select a percentage of the total per person and the shares do not have to be equal. Also, always name a contingent beneficiary in the event your primary beneficiary doesn't survive you – don’t just leave it blank.

One final word of caution -- always avoid naming your estate as the beneficiary of your retirement benefits. If you name your estate as beneficiary, it most likely means that your retirement plan will go through probate. If your probate estate is your beneficiary, several problems can arise. The biggest problem is the loss of maximizing tax deferral because the retirement plan payable to an estate would lose the right to spread out the distributions.

It's always a good idea to review your beneficiaries at least every two to three years. Also, be sure to update the right forms to reflect the changes you want. Besides having a will or a trust, the beneficiary designation is the most important estate planning tool you can use to make sure your money goes to who you want, when you want, in the most tax efficient way possible.

Securities offered through Royal Alliance Associates, Inc. Member NASD, SIPC. Advisory services offered through Matt Montgomery, a Registered Investment Advisor, 1504 East Rusk, Jacksonville, Texas, 903-586-3494.

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