Q: When my employer changed 401(k) plan providers, there was a three-week blackout period during which we couldn't access our accounts. When I was finally able to get back in to verify everything, I noticed that it stated: 'No beneficiaries have been selected'!
I quickly rectified that, but noticed there was no place to list contingent beneficiaries. When I asked HR what happened, they said: 'Oh, we are in the process of updating that, but it will take some time.' I faxed signed paperwork to the administrator to make sure my primary and contingent beneficiary designations were up to date.
I told HR that if I had died over the past three weeks during the blackout period, with no primary or contingent beneficiary assigned, it's my understanding that my account would gone to my estate, and would have to be distributed as a lump sum to my husband, without him having a chance to convert it into his own retirement account. As a result, he'd have to pay tax on the lump sum!
The employee benefits officer said 'No, your pension would always go to your husband, and the account could stay in the plan for 5 years, unless he was over over 70.' He said that under our plan, if my husband was no longer living, my account would automatically go to my kids, who also could keep it in the plan for up to 5 years. He said neither my husband nor my children would have to make any decision about the money for 5 years.
But even if that's correct, what are the tax consequences? And what if I didn't have a husband or children? --RD
A: These are good questions, and some of the answers are disquieting.
Let's start at the beginning. Every retirement account custodial agreement contains a default provision that governs what happens when there's no designated beneficiary on the account.
In IRAs, that default beneficiary is typically your estate. And if your retirement account defaults to your estate, your heirs must empty the account -- and pay taxes on it -- much faster than if they had been the designated beneficiaries. (I've explained what happens in detail here, here and here.)
401(k) plans also have a default provision. From what you say, in your plan the default beneficiaries are a) your spouse; and b) your children. "This effectively puts them on the plan as if they were designated beneficiaries, in that order," says Ed Slott, a Rockville Centre tax accountant and IRA expert.
As a result, your surviving spouse (or your kids) would have the same favorable tax options as if you'd designated them on the account: Your husband could roll the account into an IRA in his own name; and your kids could transfer it into Inherited IRAs that retained your name as the owner and listed their own names as beneficiaries, which they could empty over their life expectancies. (You'll find more about that here.)
So in your particular case, the default designation works as you would wish. But in other cases, it can have unintended and potentially costly consequences.
"I saw this situation a few years ago, when a man's 401(k) beneficiary designation was missing when he died," recalls Slott. "Under his plan's default provision, the account automatically went to his surviving spouse. But she was his second wife, and he had wanted the account to go to his kids from his first marriage. They didn't get it."
Besides, as you point out, not every plan participant has a spouse or kids. What happens to the account of an unmarried, childless participant in your company's plan if he or she doesn't have a designated beneficiary? "Their accounts probably default to their estates," says Slott. Whoever inherits the estate will get the 401(k) account, but won't be able to stretch taxable withdrawals over his or her lifetime.
You're also right that naming contingent beneficiaries can be very helpful to your survivors. (This earlier post explains why.)
The bottom line: Ask your 401(k) plan administrator to send you written confirmation of your beneficiary and contingent beneficiary designations. Keep the plan's confirmation letter where your heirs can find it -- for example, in your safe deposit box, attached to your will with a paperclip.
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