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How to Protect Your Beneficiaries From a Tax Surprise

Filed under: Taxes and Planning

Qualified plans such as 401(k)s and IRAs can be useful tools that help you save for retirement. They offer tax-deferred growth, which means you don’t have to pay taxes on the gains your investments make while the funds are in the account. But that doesn’t mean they’re completely tax-free. Eventually, the taxman will want his cut. And after you pass away, your beneficiaries are often the ones responsible for these taxes.

Estate taxes, income taxes, penalties and fees are all possibilities. If you don’t protect yourself from them, they can significantly reduce the death benefit of your 401(k), IRA or other qualified plan. There are, however, a few ways you can reduce the tax burden for your loved ones. Below are a couple of suggestions that can help protect your beneficiaries from a tax surprise:


Don’t forget your required minimum distributions (RMDs).

A typical 401(k) or IRA requires you to take distributions when you turn age 70½. The Roth IRA is the exception to this rule, but most other qualified accounts have a distribution requirement. The amount you’re required to take out depends on your age and the amount of money in your account. You can expect the distribution percentage to increase as you get older.

If you fail to take an RMD on time, you’ll face an excise tax equal to 50 percent of the missed distribution.1 If you don’t pay your excise taxes, your estate may have to do so after you pass away. Your heirs can file for a waiver, but there’s no guarantee the IRS will approve the request. Take your RMDs on time, and pay any excise taxes that arise, to ensure that your beneficiaries won’t face this risk.


Be sure to name beneficiaries.

Most qualified plans let you name one or more beneficiaries on the account. When you die, the funds in those accounts are paid directly to your beneficiaries. The funds bypass probate, which can often be a costly and time-consuming process.

If you forget to name a beneficiary, however, or if the beneficiary is dead, then your account is paid to your estate. Then it will have to go through the probate process, delaying the distribution and possibly racking up sizable administrative and legal fees. It’s not a bad idea to review your beneficiary designations and update them when necessary.


Communicate with your family.

Although the death benefit of your qualified plan might provide a big financial boost to your loved ones, it can also come with a large tax bill. A sizable distribution from either your 401(k) or your IRA might push your beneficiaries into a higher tax bracket.

If they know you’ve named them as a beneficiary, however, they can make plans to avoid or minimize the tax burden. For example, they don’t have to take the funds all at once. It’s possible for them to stretch the payments out over a couple of years or even throughout the course of their lifetime. You may want to talk with your beneficiaries so they understand their options in advance. You could even bring them to a meeting with your financial professional so they can better understand their options.

Ready to protect your beneficiaries? Contact us at Ambrose Financial & Insurance Services. We can help you evaluate your objectives and needs, and then develop a strategy. Let’s connect soon and start the conversation.




This information is designed to provide a general overview with regard to the subject matter covered and is not state specific. The authors, publisher and host are not providing legal, accounting or specific advice for your situation. By providing your information, you give consent to be contacted about the possible sale of an insurance or annuity product. This information has been provided by a Licensed Insurance Professional and does not necessarily represent the views of the presenting insurance professional. The statements and opinions expressed are those of the author and are subject to change at any time. All information is believed to be from reliable sources; however, presenting insurance professional makes no representation as to its completeness or accuracy. This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon for, accounting, legal, tax or investment advice.

16357 – 2017/1/18