Retirement assets like 401Ks, IRAs and annuities may or may not go through probate, depending on whether the owner of the asset designated a valid beneficiary prior to death.
Retirement accounts have a special ownership status because they are owned indirectly by the owner. The typical retirement account involves a “custodial” ownership for the benefit of (FBO) the “owner.” The FBO model allows the IRS to provide the special tax deferral that retirement accounts receive.
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How retirement assets work
When you create a retirement asset (for instance, by signing up for a 401k or opening an IRA), you have the option to designate a beneficiary to receive the asset upon your death. When the chosen person or entity is a valid beneficiary, the administrator of the retirement account will change the beneficial ownership to the chosen person or entity (such as a charity or trust).
This transfer of ownership is automatic and does not require probate as long as there is a valid beneficiary.
What is a valid beneficiary?
A valid Beneficiary is one that can receive the asset (is not deceased) and meets any requirements set by the administrator of the asset. For instance, many account administrators require that a married individual designate their spouse as primary Beneficiary unless the spouse waives that right.
If there is no Beneficiary or the Beneficiary chosen has predeceased the retirement account owner, then no valid beneficiary exists to receive the retirement asset.
Probate of a retirement account without a valid beneficiary
When there is no valid Beneficiary, and your financial institution has no other fallback beneficiary designation, the assets in the retirement account are transferred to the deceased’s estate and will require probate. The estate must also cash out the account within five years, which nullifies one of the primary advantages of a retirement account — being able to defer taxes. Cashing out the account will generate income taxes, which must be paid.
Choosing a valid Beneficiary— and ensuring that the Beneficiary designation remains up to date— is a simple way to secure financial assets and avoid unnecessary future expenses. Need to set up your Estate Plan so your loved ones can avoid probate?
At Trust & Will, we’re here to help you keep things simple. You can create a fully customizable, state-specific Estate Plan from the comfort of your own home in just 20 minutes. Take our free quiz to see where you should get started, or compare our different estate planning options today!
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