Estate planning is a key aspect of a successful retirement plan. Contributing to a 401(k) or employer-sponsored retirement plan is an important step in avoiding probate, as many employers will allow you to name a plan beneficiary. This allows the beneficiary to collect money without hassle. That being said, your retirement savings and estate can encompass far more than a 401(k), and will often include an individual retirement account (IRA), life insurance, and pension.

When coordinating retirement and estate planning, there are a few factors you should keep in mind.

Wills & Trusts

Drafting a will or living trust to distribute your wealth is a crucial first step in creating an estate plan. Without one, your estate will be divided in probate, which can be a long and costly process. However, not all assets must be distributed through a will. Specifically, a retirement account allows the retiree to name account beneficiaries who will receive immediate access to the accounts upon the retiree’s passing. If a beneficiary is not named in these accounts, they will land in probate.

Many people choose to name their spouse a primary beneficiary while designating their children or other family members as contingent beneficiaries. Other people may choose to leave retirement accounts to a beneficiary through a living trust. The latter may provide accounts with an increased level of flexibility and protection, and ensure assets are disbursed in a way that matches your estate planning goals. However, this option may have significant tax implications, so consult with an estate planning lawyer when creating a living trust. 

Taxes on Retirement Accounts

As a general rule, inherited property is not usually subject to income tax. Retirement accounts are a notable exception to this rule, because the funds have not been previously taxed. To that end, any funds withdrawn from a traditional IRA or 401(k) are subject to income tax at the beneficiary’s standard income rate.

When it comes to taxes, not all retirement accounts are created equal. Roth IRA withdrawals are not typically taxed. As contributions were not tax-deductible, income is allowed to accumulate tax-free, as long as the contributions remain in the account for five years or longer. Until recently, pensions—while not subject to income taxes—were subject to a 55% death tax. If the pension holder is 75 years or older, beneficiaries pay their standard income tax rate. Should the pension holder pass before age 75, beneficiaries pay no tax. 

With experience in estate planning, business planning, social security disability, family law, and personal injury cases, the attorneys at Woodlawn Law Offices in O’Fallon, MO provide clients with personalized, professional service. Stop by their website or call (636) 240-6667 to schedule a consultation.