What Happens to Your Investment Accounts When Life Happens?

Bruce Helmer and Peg Webb are financial advisers at Wealth Enhancement Group and co-hosts of “Your Money” on WCCO 830 AM on Sunday mornings. Email Bruce and Peg at yourmoney@wealthenhancement.com. Advisory services offered through Wealth Enhancement Advisory Services LLC, a registered investment adviser and affiliate of Wealth Enhancement Group.

You may spend decades building retirement savings, carefully contributing to a 401(k), IRA, Roth IRA or 529 college savings plan. But if you experience a major life event, such as a divorce or the death of a loved one, those accounts can suddenly become much more complicated.

The decisions you make during these transitions can help preserve the tax advantages you’ve worked hard to build — or they can unintentionally create unnecessary taxes, penalties or administrative headaches. That’s why your retirement accounts deserve the same attention as your investment strategy or estate planning documents.

Here are several planning considerations to keep in mind.

Divorce Involves More Than Dividing Assets

One of the biggest misconceptions during divorce is that all assets are created equal. A dollar in a brokerage account is not necessarily worth the same as a dollar in a traditional 401(k) or IRA because retirement accounts often carry future income tax obligations.

Imagine you and your spouse are deciding whether one of you should keep the family home and the other receives a larger share of the retirement accounts. On paper, the numbers may appear equal. In reality, one asset may eventually generate taxable income, while another may provide greater liquidity or receive different tax treatment.

Before agreeing to divide retirement assets, ask your financial adviser and attorney to compare their after-tax value, not simply the account balances.

The transfer process matters, too. Employer-sponsored retirement plans such as 401(k)s and 403(b)s generally require a Qualified Domestic Relations Order (QDRO), a court order that allows retirement assets to be divided without triggering unintended tax consequences. IRAs follow a different set of rules and are generally transferred “incident to divorce” under the terms of the divorce agreement. Mistakes in how assets are transferred (not just how they are  divided) can create unnecessary taxes and penalties.

Beneficiary designations deserve special attention as well. While you may assume you should immediately remove your spouse as beneficiary once divorce proceedings begin, that isn’t always appropriate. Temporary court orders, state law or the terms being negotiated may affect when beneficiary changes should occur. Before making changes during a pending divorce, consult your attorney. Once the divorce is finalized, review every beneficiary designation to make sure it reflects your wishes.

Don’t Forget Education Savings

Retirement accounts aren’t the only assets that deserve attention.

If you own a 529 college savings account, remember that you, not the beneficiary, control the account. During a divorce, deciding who should retain ownership can be just as important as deciding who will pay future education expenses.

You should also review successor-owner designations and discuss what should happen to any remaining funds after a child completes school. Under current law, some unused 529 assets may be eligible to roll into a Roth IRA for the beneficiary if specific IRS requirements are met.

Beneficiary Forms Often Matter More Than Your Will

The planning conversation changes after the death of an account owner.

Many people assume their will determines who inherits every asset. For retirement accounts, that’s often not the case. In most situations, beneficiary designation forms determine who receives IRAs, 401(k)s, and similar retirement accounts — no matter what the will says.

That’s why you should review and update your beneficiary forms after every major life event, including marriage, divorce, the death of a spouse, the birth of a child or grandchild, or retirement.

It’s also important to name both primary and contingent beneficiaries. If no beneficiary has been designated, your retirement account may pass according to the retirement plan’s terms or become part of your estate, potentially creating additional administrative complexity and different distribution rules.

Help Your Heirs Make Better Decisions

Receiving an inherited retirement account presents its own planning challenges.

Under the SECURE Act, many non-spouse beneficiaries must fully distribute inherited retirement accounts within 10 years, although some eligible designated beneficiaries follow different rules. Waiting until the 10th year is not always the best strategy. Depending on your circumstances, spreading withdrawals over several years may help manage taxable income and reduce the overall tax burden.

Inherited Roth IRAs generally follow many of the same distribution timelines for most  beneficiaries, but qualified withdrawals are generally tax-free. Understanding the differences between traditional and Roth accounts can help your beneficiaries make more informed decisions.

Keeping Your Records Organized

One of the greatest challenges families face after the death of a loved one is locating every financial account and finding the associated usernames and passwords.

Keeping an up-to-date inventory of your retirement accounts, beneficiary designations, financial institutions and key estate planning documents can save your family considerable time, stress and uncertainty.

Major life events rarely affect just one account. They often require you to review your retirement savings, education accounts, estate planning documents, insurance coverage and overall tax strategy as part of a coordinated plan, rather than one piece at a time.

Your goal during these stressful times is to help preserve the tax advantages you’ve spent a lifetime building while making the asset transfer process as straightforward as possible for the people you care about.

The original article was published in the Pioneer Press.

The opinions voiced in this material are for general information only and are not intended to  provide specific advice or recommendations for any individual. 

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