It isn't hard to set up a 401k with your employer, but you can use a few tactics to maximize your investment and ensure that your beneficiaries receive the proceeds when you're not around.
Here, Ethos will guide you through common 401k beneficiary rules to help you be sure you're not making a mistake with your 401k beneficiary.
When you begin a new job, you'll likely be asked if you want to open a 401k plan when you're onboarded. There's no good reason not to, since 401k rules are in place to benefit you and your survivors, and you'll appreciate these savings when you retire.
As part of the sign-up process, you'll need to designate a primary beneficiary or beneficiaries and contingent beneficiaries who would receive the assets if the primary beneficiary has already passed away.
In most cases, your primary beneficiary will be your spouse, if you're married. A federal law called the Employee Retirement Income Security Act, or ERISA, states a spousal waiver must be signed if the spouse is designated for less than 50% of the 401k's assets.
Often, the simplest way to handle the 401k beneficiary designation rules is to make your spouse your primary beneficiary while naming your children as contingent beneficiaries.
What if you want to name your children as primary beneficiaries? Are there 401k rules for that situation? The answer depends on the age of the children.
Let's say you're a widower, for example, with two children age 10 and 12. Since they're under age 18, you can't name them as primary beneficiaries. Instead, you'd appoint a guardian for the children to manage their finances.
Often, this is done by setting up a trust, into which the assets in the 401k would go if you were to pass away. Your children would inherit these assets either at age 18 or an age that you stipulate in the trust documentation.
If you're named a beneficiary of a 401k plan, and you're neither a spouse nor a child, you'll need to adhere to a few 401k beneficiary rules. If the person you inherited from was over age 72, they were already starting to take the required minimum distribution (RMD) that the law requires you to take when you hit that age milestone.
As the beneficiary, you'll need to continue taking at least the RMD, leaving the remainder in the plan, or rolling it into an inherited IRA account.
If the person who named you in their 401k plan was under the age of 72, there are two options. The plan's stipulations may require that you remove all the money in the plan within five years of the person's death. You can do that all at once or in distributions for five years. You'll pay income tax on the money, but there's no penalty.
Your second choice, which again depends on how the plan was laid out, is to take the money in annual distributions over your life expectancy, as is indicated in the IRS's RMD life expectancy tables. You can do this either from within the plan or via an inherited IRA that you set up with the plan's contents.
The commonality of divorce is one good reason to review your 401k beneficiary designations annually. Consider this scenario: you have a 401k plan with your long-time employer — so long that you've pretty much forgotten about it. You get divorced and remarry soon afterward. If you were to pass away, your first spouse would inherit the 401k rather than your current spouse — unless you had the foresight to visit your employer's HR department and change your beneficiary after you remarried.
It's not uncommon for individuals to forget about their plans, leaving behind money when they move on. Your new spouse won't be able to earn a judgment in their favor just by virtue of having a marriage certificate. Naming your new spouse on your will isn't enough legally to overturn the named beneficiaries in the plan.
The information and content provided herein is for informational purposes only, and it is not to be considered legal, tax, investment, or financial advice, recommendation, or endorsement. You should consult with an attorney or other professional to determine what may be best for your individual needs.