Choosing Beneficiaries Wisely, with Taxes in Mind

Choosing Beneficiaries Wisely, with Taxes in Mind


Insurance policies, IRAs and other retirement accounts all recommend that you to name a beneficiary(ies) to inherit these assets after you die. Understanding the tax and legal consequences surrounding beneficiary designations is important, not only to leave a legacy, but to also ensure estate and income taxes don’t unintentionally erode assets meant for loved ones. Here are some important points to keep in mind.

A will does not control these assets. Payments from life insurance, IRAs and retirement plans pass directly to the beneficiaries named on the contract. The content of your will does not dictate these disbursements. While this is good for your beneficiaries, it also means that you must keep your beneficiary designations up-to-date.

Spouses are the default beneficiaries of retirement plans. For married couples, federal law states that your spouse is automatically the primary beneficiary of your pension plan, 401(k) plan or other retirement plan. In fact, if you choose to name someone else, your spouse must consent in writing. This rule usually makes good tax sense, as the surviving spouse can generally roll the assets over into their own IRA, continuing tax deferral and taking annual required minimum distributions based on his or her single life expectancy.

Beneficiaries of IRAs can take distributions based on their own life expectancy. Listing children or grandchildren as beneficiaries on IRAs is a strategy often called the “Stretch IRA.” This strategy stretches the distributions of assets – and tax benefits – for years, even decades, after you die. With 401(k)s, each plan sets its own rules for non-spouse beneficiaries. Some 401(k) plans may use the same strategy as IRAs. Most 401(k) plans require beneficiaries to take distributions in one lump sum the year after death and tax the distributions as ordinary income.

Proceeds from an insurance policy are free of income tax. The distribution of death benefit proceeds is generally federal income tax free, no matter who you name as a beneficiary on life insurance policies. Unlike property disposed of in a will, insurance proceeds do not automatically go through probate.

Avoid naming minor children as beneficiaries. Generally, pension plans, IRAs and insurance policies will not pay death benefits directly to minors. Instead, a child’s guardian eventually receives the proceeds on the minor’s behalf. The key here is “eventually.” To make this process a smooth one, consider naming a child’s guardian or a trust (set up for the benefit of your children) as beneficiary. These decisions should ultimately be discussed with your attorney or tax consultant.

Keep designations current. If you have not reviewed your beneficiary designations lately, it’s time to do so. It may surprise you to find you named someone as beneficiary who passed away or omitted your youngest child because he had not been born when you opened the account.

For more information on which of the above solutions is right for you, contact a Fifth Third Bank financial advisor.

Fifth Third Bank does not provide tax or legal advice. Please consult your tax adviser or attorney before making any decisions or taking any action based on this information. This information is provided for educational purposes only and does not constitute the rendering of tax or legal advice. Fifth Third Bancorp provides access to investments and investment services through various subsidiaries, including Fifth Third Securities. Fifth Third Securities is the trade name used by Fifth Third Securities, Inc., member FINRA/SIPC, a registered broker-dealer and a registered investment advisor registered with the U.S. Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training. Securities and investments offered through Fifth Third Securities, Inc. and insurance products: Are Not FDIC Insured | Offer No Bank Guarantee | May Lose Value Are Not Insured By Any Federal Government Agency | Are Not A Deposit Insurance products made available through Fifth Third Insurance Agency, Inc. © 2018 Fifth Third Bank Excerpt from Fifth Third Bank LegacyLink.