How the SECURE Act Affects Retirement Account Beneficiaries | Lord Abbett
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Retirement Perspectives

In our latest podcast, we discuss strategies for naming a beneficiary to preserve inherited retirement assets.

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Transcript

Retirement Spotlight - Beneficiary Planning (recorded Sept. 9, 2020)

Karyn McCormack: Welcome to Retirement Spotlight, Lord Abbett's podcast series; this is Karyn McCormack. This is our third at-home podcast edition, and we're recording via Zoom again today. Antonio is our sound engineer and makes us sound great. I hope everyone listening is safe and healthy. And this week it's back to school. So in that light, we're going to learn more about beneficiary and estate planning. Our expert on this topic is Brian Dobbis, Lord Abbett's Director of Retirement Solutions. Welcome, Brian.

Brian Dobbis: Thank you for having me, Karyn.

Karyn McCormack: So let's get right to it. Why is naming a retirement account beneficiary so important?

Brian Dobbis: Good question, Karyn. Completing beneficiary paperwork for every retirement account owned is one of the most important administrative steps, in my opinion, a retirement accountholder can take. Ignoring or overlooking this seemingly easy step can lead to the wrong individual inheriting your retirement nest egg.

When an account owner dies, the inheritance - whether it's an IRA, a 401(k), or another tax-advantaged account - is not subject to probate. Instead, the inherited account becomes the beneficiary's property immediately upon death. So the named beneficiary will ultimately inherit the account.

Therefore, not naming a beneficiary can result in the decedent's retirement assets being passed to unintended recipients. So, again, Karyn, to our listeners: Very important that a designated beneficiary is named across all retirement accounts.

Karyn McCormack: So, Brian, what happens if you don't name a beneficiary on your retirement account?

Brian Dobbis: Yeah. This, unfortunately, Karyn, happens all too frequently. Accountant owners mistakenly think, or they're told, that they can use their will as the beneficiary, as they do with other assets of the estate.

But in the case of transmission funds, not naming a beneficiary leaves the determination to what's called the "default terms" of an IRA agreement or the 401(k) document. So, in essence, Karyn, the agreement and the plan document might name the estate or distribute the inheritance according to a succession order such as spouse, children, grandchildren. And this may not be what the benefactor had in mind. So, in essence, Karyn, if you don't name a beneficiary, you're subject, or stuck with, the rules of the agreement that oversee your IRA and/or your 401(k).

Karyn McCormack: Yes, Brian, it's so important. What are some of the common mistakes you see when it comes to naming a beneficiary?

Brian Dobbis: First and foremost, thinking heirs will inherit your retirement accounts based on your will. I cannot stress enough the importance of naming a beneficiary directly on your form. Do not name your will. Name the individual and/or individuals you would like to inherit your assets.

Secondly, Karyn, the one I see all too frequently throughout my career is naming the estate. Naming the estate as your beneficiary is generally prudent. Why? Although your heirs will eventually receive the inheritance, it will generally not be in the most tax-efficient manner. So, again, Karyn, name a beneficiary for every tax-qualified account: IRAs, 401Ks, your health savings account. And, ideally, you do not want to name your estate for various reasons.

Karyn McCormack: Brian, can you expand on that? Why is it not a good idea to name the estate as a beneficiary?

Brian Dobbis: Great question, Karyn. The estate is not a living, breathing entity. The estate is that: It's just an entity. When you name the estate, generally the underlying heirs will eventually receive the assets, but not in the most tax-advantaged way. Therefore, the post-death payout will, in m-- most cases, be shorter.

For example, some beneficiaries will still-- post-SECURE Act, which we'll discuss in a little while, can still stretch based off their life expectancies. And other beneficiaries will have, at minimum, a ten-year post-death payout. More times than not, Karyn, when you name the estate, the rules are not as liberal, and sometimes you're limited to a maximum of a five-year payout.

So again, for our listeners, if you're considering naming the estate, or you've named the estate, I would get in touch with your financial team and take a deep dive into why naming the estate as your retirement account beneficiary is not prudent.

Karyn McCormack: Okay. So it's important to notice details. Now a lot of people might have different kinds of retirement accounts: 401K, IRA. What are the differences in naming your beneficiary on those different accounts?

Brian Dobbis: Beneficiary options for 401(k) and IRA plans are similar in many ways, but different in other areas. And probably, in my opinion, some of the major differences are IRAs are not subject to federal law known as "ERISA:" The Employee Retirement Income Security Act, and therefore are not subject to spousal consent. Meaning, Karyn: In a 401(k), or any other retirement plan subject to ERISA, you must name your spouse as your primary beneficiary.

Whereas, in an IRA, which is generally not subject to ERISA, unless you reside in a community property state, generally you can name any individual you want, spouse or not. And I think this is something-- this is a provision, or re-- or something-- a nuance that a lot of people aren't aware of until it's too late. So when you're reviewing your beneficiaries, naming your beneficiaries-- marriage, spousal-- situations, family dynamics, and, of course, federal law all come into play.

Karyn McCormack: Brian, earlier you mentioned the SECURE Act. It's called the "Setting Every Community Up for Retirement Enhancement" Act. It was passed in December 2019. It has a bunch of provisions that affect retirement plans. How does that new law affect beneficiary designations?

Brian Dobbis: The SECURE Act limits the time period over which most, not all, beneficiaries can withdraw inherited retirement assets to a maximum of ten years. Whereas, pre-SECURE Act, post-death withdrawals were based on a beneficiary's life expectancy. And it's very important to note, Karyn, that the SECURE Act w-- this provision of the SECURE Act went into effect for deaths that occur on or after January 1st, 2020.

Karyn McCormack: Brian, you said the SECURE Act limited the time period over which most beneficiaries can get their assets post-death. Which beneficiaries can still stretch out those d-- after-death payouts?

Brian Dobbis: The SECURE Act eliminated the stretch post-death payout strategy for most beneficiaries, and it limits most non-spouse beneficiaries to a maximum of a ten-year payout. But as mentioned, Karyn, the Act excludes five categories of beneficiaries.

Brian Dobbis: So, in essence, the five categories of beneficiaries I'm about to reference are excluded from the ten-year rule, and can still stretch, based on their life expectancy, to a degree. These five categories of beneficiaries are called "eligible designated beneficiaries."

And they are as follows, Karyn: spouse beneficiaries; minor children of the account owner, and-- for our listeners, grandchildren are not included; individuals who are not more than five years younger than the account owner; if you're chronically disabled or chronically ill: Any of those five categories of beneficiaries fall under pre-SECURE Act rules, and therefore can still stretch based off their life expectancy.

With one caveat: And that is the minor children of account owners. Here, the minor can stretch the receipt of the inherited retirement account until they reach the age of majority, which for most states is age 18. At which point they then flip the switch to the ten-year period. So put another way: Upon-- turn-- turning-- 18, age of majority, you are then subject to the ten-year rule-- and forced to in-- receive the entire account within ten years following the year of the death.

Karyn McCormack: Brian, I thought I would give our listeners an example of how the stretch payout works. Marie, age 75, dies on December 29th, 2019. Margaret, her daughter, is age 50: She is the sole beneficiary of Marie's IRA. According to the IRS, life expectancy of a 50-year-old is 34.2 years.

Margaret could then stretch those payouts from her inherited IRA for more than 34 years. Now, the SECURE Act has eliminated this option for most beneficiaries. What has changed? The post-death beneficiary payout schedule.

Let's just say that Marie passed a few days later, on January 1st, 2020. Margaret, her daughter, has now lost the ability to stretch those payouts from 34.2 years to a maximum payout of ten years under the SECURE Act rules.

Brian Dobbis: So, Karyn, in that example, the beneficiary lost over 20 years of potential-- stretch payouts from a tax-deferred account due to the SECURE Act.

Karyn McCormack: Yeah, that's quite a difference. What are some of the other-- best practices for naming a beneficiary, Brian?

Brian Dobbis: Yeah. I have-- a list that I've accumulated-- over the years based on questions I've received, inquiries, some errors, common errors. And Karyn, they're all important, so this is in no particular order. But, please, make sure a beneficiary has been named on all tax-advantaged accounts. Review designations at least annually, and make updates as needed.

Make sure all the forms are completed, meaning make sure they're all signed and dated. If there is more than one beneficiary, make sure the allocation equals 100. I've seen scenarios where they're greater or less than 100. Always name a contingent beneficiary. Make sure the relationship to the beneficiary is clear. "This is my spouse," "This is my child," "This is my grandchild."

And for our ERISA-covered plans, again, the spouse must be named the primary beneficiary unless they waive their rights. And finally, let your heirs know that they have been named beneficiary of your retirement account. So, again, Karyn, a lot of best practices to ensure that your hard-earned nest egg is provided or given to your heirs in the most tax-advantageous way available.

Karyn McCormack: These are all so important, Brian, so important for estate planning and to keep money in the family, right?

I'd like to give your listeners a few key takeaways from our discussion today. 1) You must name a primary beneficiary and at least one contingent beneficiary to whom the assets will pass if the primary beneficiary has died. 2) Beneficiary designations for 401(k)s override the contents of a will. 3) 401(k) and other qualified retirement plans require the spouse to be the sole, primary beneficiary.

Hopefully, our discussion today will let you learn more about beneficiary planning. We also have a recent article on our website: LordAbbett.com/retirementperspectives. And you can find more information there. You can also follow Lord Abbett on LinkedIn to see our most updated retirement articles.

Advisors, if you have additional questions, please contact your Lord Abbett representative at 888-522-2388. Individual investors, please contact your financial advisor and/or accountant if you have any questions. Thanks for listening to our at-home edition of Retirement Spotlight. We hope you're all staying safe and healthy. Ta-Ta for now!

ANNOUNCER: That's it for this addition of Retirement Spotlight. Please drop us a line on social media, or visit our website at LordAbbett.com. Our audio podcasts are available on iTunes, Spotify, TuneIn, and other major streaming media services. Thanks for listening.


DISCLOSURES

ERISA, The Employee Retirement Income Security Act of 1974, protects Americans' retirement assets by implementing rules that qualified plans must file to ensure that plan fiduciaries do not misuse plan assets. Under ERISA, plans must provide participants with information about plan futures and funding, and regularly furnish the information free of charge.

To comply with Treasury Department regulations, we inform you that, unless otherwise expressly indicated, any tax information contained herein is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law, or (ii) promoting, marketing, or recommending to another party any transaction, arrangement, or other matter.

The information is being provided for general educational purposes only and is not intended to provide legal or tax advice. You should consult your own legal or tax advisor for guidance on regulatory compliance matters. Any examples provided are for informational purposes only and are not intended to be reflective of actual results and are not indicative of any particular client situation.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett's products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

GLOSSARY

Traditional IRA contributions plus earnings, interest, dividends, and capital gains may compound tax-deferred until you withdraw them as retirement income. Amounts withdrawn from traditional IRA plans are generally included as taxable income in the year received and may be subject to 10% federal tax penalties if withdrawn prior to age 59½, unless an exception applies.

A Roth IRA is a tax-deferred and potentially tax-free savings plan available to all working individuals and their spouses who meet the IRS income requirements. Distributions, including accumulated earnings, may be made tax-free if the account has been held at least five years and the individual is at least 59½, or if any of the IRS exceptions apply. Contributions to a Roth IRA are not tax deductible, but withdrawals during retirement are generally tax-free.

A 401(k) is a qualified plan established by employers to which eligible employees may make salary deferral (salary reduction) contributions on an aftertax and/or pretax basis. Employers offering a 401(k) plan may make matching or nonelective contributions to the plan on behalf of eligible employees and may also add a profit-sharing feature to the plan. Earnings accrue on a tax-deferred basis.

This broadcast is the copyright © 2020 of Lord, Abbett & Co. LLC. All Rights Reserved. This recording may not be reproduced in whole or in part or any form without the permission of Lord Abbett. Lord Abbett mutual funds are distributed by Lord Abbett Distributor LLC.

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