They can—unless you designate your beneficiaries properly
Some assets always pass through the probate process, while others may not. Your retirement accounts may end up in probate after you die, depending on how you handle them when you're alive. If you choose your beneficiaries strategically, you can avoid that cumbersome and costly fate—and save your heirs a lot of hassle. Here's what you need to know.Probate is a legal process that authenticates and validates someone's will.
The process involves the review of a deceased individual's assets and determines their heirs. While probate isn't always necessary, it generally kicks in when someone's estate is of great value. As such, it can be a long, drawn-out, and costly process.
When a person dies, most of their assets are frozen until their will is validated, all of their debts are paid, and their beneficiaries are identified. This is the legal process known as probate. The probate process can happen rapidly or at a frustrating crawl.
Retirement account assets have the potential to bypass probate. This includes individual retirement accounts (IRAs), 401(k)s, 403(b)s, and a number of less-common types of retirement accounts. The reason: When someone opens a retirement account, part of the paperwork includes naming one or more beneficiaries who inherit the account when the owner dies.
The financial institutions where the accounts are held (often referred to as custodians) must hand over those assets to the named beneficiaries upon the owner's death. The contract between the account holder and custodian takes the place of the will for these assets, keeping them out of probate.
Important: If retirement accounts don't go through probate, creditors can't collect debts from them.
As with anything, there are exceptions to the rules that we mentioned in the earlier section. As such, there are several ways that retirement accounts can end up in probate. This usually results from a simple misstep—notably, messing up the beneficiary designation. Here are some examples of how that can happen.
Not Naming Your Spouse, If Necessary
A spouse is entitled to half of anything the other spouse adds to their retirement account during the marriage in community property states—notably, Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, Wisconsin, and in some cases, Alaska, South Dakota, and Tennessee.
That means if the retirement account owner names other beneficiaries in addition to (or instead of) their spouse, the spouse can file a claim to take part of the assets. Doing so will send any retirement accounts the deceased individual has to probate.
In all states (and especially community property states), a married person must name their spouse as beneficiary to a 401(k) unless that spouse signs a special waiver.
What if you don't name any of your heirs as the beneficiaries of your retirement accounts? If you don't list anyone, your assets will have to go through probate. And a probate court will have to establish an estate for you if you didn't already. There are no clear-cut benefits to doing this, as it will complicate matters even more.
Your estate becomes a non-designated beneficiary rather than a designated one. And there are special rules that apply to this kind of heir. For instance, the money in your account must be distributed within five years after your death.As such, the estate must remain intact until the account is drained.
Bill collectors will also be able to get their share before any beneficiaries get theirs. So, if you have any outstanding debts, your creditors can file a claim to get a hold of any of your assets, including your retirement accounts.
Any money that goes through the probate process may also incur estate taxes if its value exceeds the federal exclusion amount. The filing threshold for an estate for 2022 is $12.06 million. The threshold increases to $12.92 million in 2023 to account for inflation.You may also be required to pay an estate tax to your state in addition to the federal government, if applicable.
You can name your child(ren) or other minors as beneficiaries of your retirement account. Keep in mind, though, that minors cannot hold assets with substantial value in their own names. As such, they require someone to manage assets like these for them.
To avoid probate, you must ensure that you designate someone who will manage the money for any beneficiaries who are still minors. They are responsible for overseeing these assets until minor beneficiaries become adults. Any financial institution can help navigate the Uniform Transfers to Minors Act (UTMA).
Warning: You are considered intestate if you die without a will. Any assets you have are passed to your heirs based on your state's inheritance laws rather than to any beneficiaries you elected during your lifetime.
Your assets, including any retirement accounts you have, will pass through probate if anything happens to your beneficiary. This includes:
Probate is also a possibility if your beneficiary becomes incapacitated in any way. When this happens, the probate court has to elect a guardian to oversee any financial matters for them. This normally requires the supervision of the court to ensure that the funds aren't mishandled or misappropriated.
Retirement accounts do not have to go through the probate process if you designate beneficiaries properly. For instance, naming a spouse or an adult child as a beneficiary means the account won't have to go through probate. But probate does kick in if you don't name any beneficiaries, leave the accounts to your estate, or name a minor child.
Retirement accounts aren't considered part of an estate, provided the account holder ensures that beneficiary designations are properly filled out. So if you name your spouse or someone else (with your spouse's written consent in community property states), your retirement accounts are not considered part of your estate. As such, they will go directly to your beneficiaries.
The beneficiary inherits a retirement account when the account owner dies as long as they are a designated beneficiary and are of legal age. In community property states, the account owner's spouse must be listed, or their written authorization must be obtained to designate someone else. If the account owner dies without naming a beneficiary, the account must pass through probate with any other assets. The court decides how the estate will be divided.
Retirement accounts can smoothly and painlessly pass to the beneficiaries named on those accounts as long as you avoid some mistakes. Try to review your beneficiary designations at least once a year or when major life changes happen, such as divorce, remarriage, the death of a former beneficiary, or the birth of a new one.
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