If you die with funds remaining in your retirement accounts—like a pension, IRA, or a 401k—those funds normally pass to named beneficiaries without probate. But complications can occur, and if you don’t keep your beneficiary designations up-to-date, those accounts could end up in probate, or worse.
Name Beneficiaries to Avoid Probate
Normally, when you establish a retirement account, you name beneficiaries who will receive any funds remaining in the account when you die. Those funds go directly from the company holding the funds to the beneficiary, without probate. The beneficiary makes a claim and the company makes a payment or a series of payments to that person—no courts involved.
If you don’t name a beneficiary, the funds will go into your estate and will be distributed through probate, causing delays, reducing the amount received by the beneficiaries, and limiting payout options.
So if you haven’t named beneficiaries your retirement account—or if you can’t remember—contact your account administrator. Naming a beneficiary is usually just a matter of filling out a simple form, and you may even be able to do it online.
When naming beneficiaries, here are a few tips to keep your retirement accounts out of probate:
- Name your spouse. If you are married and live in a community property state, half of the money that you earn during marriage belongs to your spouse. This means that half of the money you add to your retirement account during your marriage actually belongs to your spouse. So if you don’t name your spouse as a beneficiary, your spouse could claim part of the account after you die. Among other issues, this legal complication could cause your retirement account to end up in the probate court. To avoid this, name your spouse as beneficiary or have your spouse sign a waiver agreeing not to make a claim to it. Further, in all states, 401(k) plans require you to name your spouse as beneficiary (or get a waiver). So when in doubt, name your spouse--or get help from an attorney or CPA.
- Name alternates. When you name a beneficiary for your account, you can usually name alternates who would take the property if the first beneficiary is not available to receive them. Naming alternates is almost always a good idea. If you don’t, and your first beneficiary is not available to receive the funds when you die, the funds in the account will be paid to your estate and distributed through probate.
- Name a person, not your estate or trust. Don’t be tempted to name your estate as the beneficiary. Some people like this idea because they think that they can make a more complicated distribution through their will or because they like the idea of naming all beneficiaries in one place. However, money that’s distributed through your estate will go through probate—and this is likely to mean that there will be less money for your beneficiaries, it will take longer for them to get it, and they will have fewer options about how to receive it. Similarly, if you have a living trust, you generally should not name the trust as the beneficiary of your retirement benefits. Probate won’t be an issue, but if you name your trust the beneficiary, the final beneficiaries may lose some of the funds, as well as some flexibility to use those funds. If you want to name a trust for the purpose of controlling the funds over time (perhaps for a beneficiary who might blow it all at once), see a lawyer for help.
- Make arrangements for minor beneficiaries. Minors cannot receive funds from your retirement account outright. Someone will need to manage the account for your young beneficiaries until they become adults. You can set up this kind of property when you open your up your account, or you can add it later. Most people use the Uniform Transfer to Minors Act (UTMA) to name a custodian for the account until the minor becomes an adult. The UTMA is simple and familiar to most financial institutions. To set up an UTMA custodianship for your young beneficiaries, ask your account administrator for help. If you want to set up property management that is more complicated or long-lasting—like a special needs trust, child’s trust, or spendthrift trust--ask an estate planning attorney for help. If you leave your retirement accounts to minor beneficiaries without setting up property management, the court may have to step in to do it for you.
- Keep your beneficiary designations up-to-date. You can change your named beneficiaries anytime. So as your wishes or circumstances change, contact your account administrator to update beneficiary information. This could be especially important as beneficiaries die or if you get married, have children, or get divorced. If a named beneficiary dies first and then you die, it will be as if you had no beneficiary named – and your account funds will likely end up in probate. Perhaps even worse, if you die with your former spouse as your named beneficiary, your ex-spouse will have a claim to those retirement funds, even if you haven’t spoken in years or if you’ve remarried. To avoid pitfalls, review your retirement accounts annually to make sure that the right beneficiaries are on record.
Why & How to Avoid Probate
Probate is the court procedure of settling the estate of a deceased person. Probate inventories and distributes that person’s property after settling any creditor claims. Probate can take months or years to complete, and between court fees, lawyer’s fees, and executor’s fees, it can cost the estate a lot of money—leaving less for beneficiaries. While probate can be useful for some estates, especially those with complicated holdings or a lot of debt, for most simple estates, probate is often a waste of time and money. This is why many people plan ahead to have their estates avoid probate.
To avoid probate, you must plan to have your property pass in ways not subject to the probate process. For example, property passed through these estate planning tools usually avoid probate:
- Living trusts
- Life insurance
- Beneficiary designations (retirement accounts fall under this category)
- Pay on death accounts
- Joint tenancy, tenancy by the entirety, and community property with the right of survivorship
- Transfer-on-death deeds (also called beneficiary deeds)
With these tools, property transfers directly to the beneficiary, and the court only gets involved if there is a problem—like if all named beneficiaries are dead or if the estate does not have enough money to cover debts and expenses. If problems cause these “non-probate assets” to end up in probate, they become part of the probate estate, and they will be subject to the same fees as any other probate property.
To keep your retirement accounts out of your probate account, make sure you’ve named beneficiaries (including alternates), provide property management for minor beneficiaries, and keep your beneficiary designations up to date.
A Lawyer Can Help
If you are interested in managing your finances and your property to avoid probate, contact an experienced estate planning attorney for advice.
Questions for Your Attorney
Here are some questions
- I am married but don't want to leave retirement benefits to my spouse - what are my options?
- What’s the best way to leave my retirement accounts to my son who has a severe physical disability?
- What are the different payment options available for receiving retirement benefits and what are the tax consequences of each?