When was the last time you reviewed your beneficiary designations? The beneficiaries you name on your financial accounts take precedence over a trust or will. That’s why making sure your beneficiary designations are current is critical. We recommend reviewing your beneficiaries annually, and after major life events like marriage, divorce, a new child, and death.
When you open accounts like IRAs, 401(K)s, and Health Savings Accounts you are asked to name your primary and contingent beneficiaries. A common mistake is not naming contingent beneficiaries. If your primary beneficiary passes, and there’s no contingent beneficiary, your assets will go to your estate and the probate process. If you don’t have a will, a court will decide who inherits your assets. Certain accounts like 401(K)s have strict rules requiring you to name your spouse as the primary beneficiary. Your spouse must agree, in writing, to naming someone else.
Your beneficiary can be a person, a charity, a trust, or your estate. Who you name as a beneficiary, including the type of financial account you designate to them, can have major tax (and non-tax) implications. For example, if you’re an adult child, would you rather inherit assets from a Roth or pre-tax IRA? You’ll enjoy tax-free withdrawals from the Roth versus having to pay ordinary income taxes on withdrawals from the pre-tax IRA.
Your spouse
Your spouse is the only person who can inherit your IRA and treat it like it is theirs. Spouses can roll over inherited IRA assets into an existing or new IRA. This may be a good option if the surviving spouse won’t need to use the IRA funds or she’s above 59 ½ years old. Another option is to transfer the assets to an inherited IRA. A spouse can withdraw assets in an inherited IRA without penalty. There are additional rules such as continuing required minimum distributions once they’ve begun or ensuring the assets stay in a Roth IRA for 5 years before withdrawing them, so you’ll want to consult with your Azzad Advisor.
Minors (children under 18)
If you name minor children or grandchildren as beneficiaries, then your will must name a guardian to manage the assets on their behalf. If you want your minor children to be able to access your assets while they’re still children, then setting up a trust or custodial account may be a good solution. If you have a child with special needs or an adult child whom you don’t think should receive the assets outright, you may want to set up a special needs trust on their behalf.
Other non-spouse beneficiaries
With the passing of the SECURE Act, naming a non-spouse as your retirement account’s beneficiary can have significant tax consequences. The 10-Year Rule means that most non-spouse beneficiaries will be required to distribute the entirety of their inherited retirement accounts by the end of the tenth year after your death. Previously, they could shelter a large portion of the inheritance from taxes by “stretching” it out among their life expectancy.
A trust, charity, or one’s own estate
Be aware of the implications when naming a non-person beneficiary and how that may affect your estate planning goals. Doing so can have major implications depending on the type of financial account. If naming a trust, consider reviewing its provisions to ensure it is still current and relevant to your wishes. A common mistake we observe with clients is creating a trust, only to overlook transferring assets (including property) into it. If you are charitably inclined, consider assets that are better suited for charitable giving. These are assets that do not receive a step-up in basis (i.e., non-qualified accounts) and/or assets that are taxed as ordinary income (i.e., pre-tax qualified accounts).
What about the Islamic inheritance rules?
Prominent scholars, including those on Azzad’s Shariah Advisory Board have concluded that retirement accounts are not necessarily included in a Muslim’s estate, and that it’s okay to name beneficiaries outside an Islamic will.
Why? Retirement accounts permit ongoing contributions from employers and employees, and they are generally not considered fully owned by the account holder. For this reason, among others, they are not part of the owner’s estate. And since a retirement plan or pension is not considered part of an account owner’s inheritance, the preselected beneficiaries are entitled to receive the benefit.
If someone passes away without selecting a beneficiary, our scholars note that those assets should be distributed according to Islamic inheritance rules.