Selecting beneficiaries
for retirement benefits is different from choosing beneficiaries for other
assets such as life insurance. With retirement benefits, you need to know the
impact of income tax and estate tax laws in order to select the right beneficiaries.
Although taxes shouldn't be the sole determining factor in naming your
beneficiaries, ignoring the impact of taxes could lead you to make an incorrect

In addition, if you're
married, beneficiary designations may affect the size of minimum required
distributions to you from your IRAs and retirement plans while you're alive.

Paying income tax on most retirement distributions

Most inherited assets such as bank
accounts, stocks, and real estate pass to your beneficiaries without income tax
being due. However, that's not usually the case with 401(k) plans and IRAs.

Beneficiaries pay ordinary income tax
on distributions from pretax 401(k) accounts and traditional IRAs. With Roth
IRAs and Roth 401(k) accounts, however, your beneficiaries can receive the
benefits free from income tax if all of the tax requirements are met. That
means you need to consider the impact of income taxes when designating
beneficiaries for your 401(k) and IRA assets.

For example, if one of your children
inherits $100,000 cash from you and another child receives your pretax 401(k)
account worth $100,000, they aren't receiving the same amount. The reason is
that all distributions from the 401(k) plan will be subject to income tax at
ordinary income tax rates, while the cash isn't subject to income tax when it
passes to your child upon your death.

Similarly, if one of your children
inherits your taxable traditional IRA and another child receives your
income-tax-free Roth IRA, the bottom line is different for each of them.


Naming or changing beneficiaries

When you open up an IRA or begin
participating in a 401(k), you are given a form to complete in order to name
your beneficiaries. Changes are made in the same way--you complete a new
beneficiary designation form. A will or trust does not override your
beneficiary designation form. However, spouses may have special rights under
federal or state law.

It's a good idea to review your
beneficiary designation form at least every two to three years. Also, be sure
to update your form to reflect changes in financial circumstances. Beneficiary
designations are important estate planning documents. Seek legal advice as


Designating primary and secondary beneficiaries

When it comes to beneficiary
designation forms, you want to avoid gaps. If you don't have a named
beneficiary who survives you, your estate may end up as the beneficiary, which
is not always the best result.

Your primary beneficiary is your first
choice to receive retirement benefits. You can name more than one person or
entity as your primary beneficiary. If your primary beneficiary doesn't survive
you or decides to decline the benefits (the tax term for this is a disclaimer),
then your secondary (or "contingent") beneficiaries receive the


Having multiple beneficiaries

You can name more than one beneficiary
to share in the proceeds. You just need to specify the percentage each beneficiary
will receive (the shares do not have to be equal). You should also state who
will receive the proceeds should a beneficiary not survive you.

In some cases, you'll want to designate
a different beneficiary for each account or have one account divided into
subaccounts (with a beneficiary for each subaccount). You'd do this to allow
each beneficiary to use his or her own life expectancy in calculating required
distributions after your death. This, in turn, can permit greater tax deferral
(delay) and flexibility for your beneficiaries in paying income tax on


Avoiding gaps or naming your estate as a beneficiary

There are two ways your retirement
benefits could end up in your probate estate. Probate is the court process by
which assets are transferred from someone who has died to the heirs or
beneficiaries entitled to those assets.

First, you might name your estate as
the beneficiary. Second, if no named beneficiary survives you, your probate
estate may end up as the beneficiary by default. If your probate estate is your
beneficiary, several problems can arise.

If your estate receives your retirement
benefits, the opportunity to maximize tax deferral by spreading out
distributions may be lost. In addition, probate can mean paying attorney's and
executor's fees and delaying the distribution of benefits.


Naming your spouse as a beneficiary

When it comes to taxes, your spouse is
usually the best choice for a primary beneficiary.

A spousal beneficiary has the greatest
flexibility for delaying distributions that are subject to income tax. In
addition to rolling over your 401(k) or IRA to his or her IRA or plan, a
surviving spouse can generally decide to treat your IRA as his or her own IRA.
These options can provide more tax and planning options.

If your spouse is more than 10 years
younger than you, then naming your spouse can also reduce the size of any
required taxable distributions to you from retirement assets while you're
alive. This can allow more assets to stay in the retirement account longer and
delay the payment of income tax on distributions.

Although naming a surviving spouse can
produce the best income tax result, that isn't necessarily the case with death
taxes. At your death, your spouse can inherit an unlimited amount of assets and
defer federal death tax until both of you are deceased (note: special tax rules
and requirements apply for a surviving spouse who is not a U.S. citizen). If
your spouse's taxable estate for federal tax purposes at his or her death
exceeds the applicable exclusion amount, then federal death tax may be due. In
other words, one possible downside to naming your spouse as the primary
beneficiary is that it may increase the size of your spouse's estate for death
tax purposes, which in turn may result in death tax or increased death tax when
your spouse dies.

Naming other individuals as beneficiaries

You may have some limits on choosing
beneficiaries other than your spouse. No matter where you live, federal law
dictates that your surviving spouse be the primary beneficiary of your 401(k)
plan benefit unless your spouse signs a timely, effective written waiver. And
if you live in one of the community property states, your spouse may have
rights related to your IRA regardless of whether he or she is named as the
primary beneficiary.

Keep in mind that a nonspouse
beneficiary cannot roll over your 401(k) or IRA to his or her own IRA. However,
a nonspouse beneficiary can directly roll over all or part of your 401(k)
benefits to an inherited IRA.


Naming a trust as a beneficiary

You must follow special tax rules when
naming a trust as a beneficiary, and there may be income tax complications.
Seek legal advice before designating a trust as a beneficiary.


Naming a charity as a beneficiary

In general, naming a charity as the
primary beneficiary will not affect required distributions to you during your
lifetime. However, after your death, having a charity named with other
beneficiaries on the same asset could affect the tax-deferral possibilities of
the noncharitable beneficiaries, depending on how soon after your death the
charity receives its share of the benefits.