Stapleton Elder Law

Protect Your Retirement by Avoiding these 401(k) Mistakes

The younger you are, the more time you have to make all the right moves when it comes to your 401(k) retirement savings accounts.

There’s good news and bad news when it comes to statistics about retirement and American’s use of 401(k) accounts, as reported in Kiplinger’s article, “The 7 Most Common 401(k) Mistakes to Avoid.” The good news starts with a report from the Investment Company Institute: the entire 401(k) system had $4.8 trillion in assets as of March 2016, representing 52 million active plan participants, former employees and retirees. There’s also good news from Vanguard also, which reports that the average 401(k) balance reached $101,650— which is a record high.

However, there is bad news. Nearly half (45%) of the 38 million working-age households don’t own any retirement account assets, including IRA accounts or an employer-sponsored 401(k) plans.

The employer-sponsored 401(k) plan started in 1978.  Therefore, it’s been available to millions of workers who are now 65-years-old and who could’ve been using it to save for retirement and save on their taxes. However, only half of Baby Boomers have more than $100,000 in a 401(k) or other retirement plan.

The good news is that younger workers have much of their working lifetime to accumulate a retirement fund. They also have the advantage of participating in 401(k) plans that have become far more sophisticated. This means that it’s a little bit more complicated for participants to understand all of the plan choices. As a result, some will make mistakes. A good goal is to save $1 million over your career to allow you to withdraw $5,000/month for 30 years with a 6% annual investment return.

Here are some common mistakes that retirement plan participants make and what they should be doing to avoid them.

Not Saving Enough. Simple math, right? To accumulate $1 million in monthly increments, you need to defer about $1,000 per month, every month, for 30 years with a 6% annual return.

Starting Too Late. Time and the power of compound interest must be worked to your advantage. The more time you have to accumulate savings, the more time the returns will have to work in your favor. Start to save right out of college, even if it’s a small amount, to make saving easier on you down the road.

Not Maxing Out. You need to “max out” your employer match. For example, if you make $75,000 per year and put away 3% ($2,250), and the employer matches, your total annual contribution is $4,500. That won’t even get you halfway to that $1 million. But on that same salary, if you defer 13% into the retirement plan ($9,750 or $812.50 per month), and your employer matches the first 3% of your contribution, that’s an additional $2,250, for a total of $12,000. The employer match is like getting a 23% return on your contribution!

Priorities. Many people don’t pay themselves first. Most 401(k) plans have an option to set an increase in your contribution rate annually, until you’re making maximum contributions. If you’re a single taxpayer, a $9,750 contribution will save you at least $2,437 in federal income tax.

Taxes. There are tax savings that are possible. How about $200 per month? Your paycheck won’t go down quite as much as the entire contribution to the plan, because there are fewer withholding taxes. In our example, we assume a conservative 6% annual return. Two factors affect returns in a retirement plan. They are fund selection and asset allocation.

Doing Nothing. This means not taking advantage of the plan’s available tools to develop an allocation plan. Spread your contributions over a variety of funds that represent a broad selection of asset classes. A large percentage of plan participants don’t even take the time to change their fund selections from the default fund the plan offers.

Monitoring and Rebalancing. Things change over the course of time, and your portfolio should also. That means rebalancing, which is sometimes offered as a feature of the account. Another is keeping track of account balances. It’s your retirement, so you should be aware of how your money is growing.

Today’s 401(k) plans are loaded with features to help you understand your investments and how to make saving for retirement easier than in the past. If you haven’t reviewed your 401(k) in a while, now would be a good time to do so!

Reference: Kiplinger (July 2017) “The 7 Most Common 401(k) Mistakes to Avoid”

Please visit our website to learn more about retirement planning.

 

Changes to Retirement Contribution Deductions May Be Part of Tax Reform

Don’t be surprised if DC decides to find some much-needed revenue from retirement contribution deductions. It could change how Americans save for retirement.

A large part of the tax reform debate now underway, concerns overhauling the corporate tax code.  However, attention is also turning to American’s retirement savings. That could have a huge impact on individuals, according to CNBC in “Tax reform could change the way you save for retirement.”

The Trump White House and Republicans say they want to streamline the tax system, by allowing Americans to file their returns using just a large postcard. To do that, they’re thinking of eliminating most of the individual deductions, except for mortgage interest and charitable donations. The White House then said that it would also preserve the deduction for 401(k) contributions. However, the Save our Savings Coalition is concerned that this could come with some large exceptions. Deductions for retirement contributions are worth $583.6 billion through 2020. That source could be hard for lawmakers to resist, as they look for ways to pay for tax cuts.

Individuals can now defer taxes on the money they save for retirement, until it’s withdrawn. That encourages households to save, since their tax rate is usually lower during retirement than when they’re working and saving.

However, there are proposals on Capitol Hill that would change when that money gets taxed. One plan permits half of the allowable retirement contributions to be taxed up front. However, households would be able to withdraw the money in retirement tax-free, like a Roth IRA.

Senator Jeff Flake, R-Ariz., and Representative Dave Brat, R-Va., introduced a bill that would create a new universal savings account in which consumers could contribute $5,500 after taxes. Unlike a retirement account, withdrawals could be made at any time tax-free with no penalties. This was included in the House blueprint for tax reform.

Another proposal that’s frequently discussed is capping the level of deferred contributions. The current limits are $18,000 a year for a 401(k) and $5,500 for an IRA (with annual adjustments for inflation). That’s been identified as a potential revenue raiser. This is critical because Republicans say that tax reform will be revenue neutral (any tax cuts will be paid for with revenue from somewhere else). The GOP plan would consolidate households into three tax brackets of 12, 25 and 33% in a move that would lower the top rate by 6.6%.

According to the Tax Policy Center, the decrease in personal rates alone could cost $2.6 trillion over the next ten years, and that’s not including the impact of economic growth. If policymakers are looking for revenue, says one former lawmaker, they are more than likely to train their sights on American retirement accounts. The money has to come from somewhere!

Reference: CNBC (June 29, 2017) “Tax reform could change the way you save for retirement”

Please visit our website to learn more about retirement planning and the laws in Virginia.

401(k) Fundamentals You Need to Know Now

Making sure that your 401(k) and other retirement accounts align with your overall retirement strategy, is part of the planning for a successful retirement, whether that date is in the future or coming up soon.

Most working people count on their 401(k)s as the biggest part of their retirement accounts, and making decisions about how to invest these funds, as part of their overall retirement savings plan, can be a bit overwhelming. However, as reported in Kiplinger in “6 Answers to Your 401(k) Questions,” there are some basics to get you started on the right path.

How do I enroll? If your employer has a retirement plan,  such as a 401(k) or a 403b, your Human Resources department should talk about enrolling when you’re hired. If you’ve been there a while, most companies will hold a group meeting with HR and a representative from the plan sponsor. They will go through the highlights of the plan and help you to enroll. There are a couple of things to bear in mind: figure out the company match and take advantage of it; and if there’s no company match, you may want to look at a personal Roth IRA and IRA contributions before going with your employer’s retirement plan.

Which one: Roth or Traditional IRA? Some employer retirement plans are offering Roth options, so choosing between traditional or Roth to save for retirement is important. In a traditional 401(k), you’re not getting a tax deduction for your pre-tax contributions, but instead are getting a tax deferral. You’ll eventually pay taxes on the money in these accounts funded with pre-tax dollars when you take withdrawals in retirement. You’ll pay tax on the pre-tax contributions and all of the gains.

For a Roth, you invest post-tax dollars going into the account and won’t be taxed again. Withdrawals in retirement are tax-free for your contributions and your growth. Therefore, do you want to pay the taxes now (on a Roth) or pay taxes during retirement (with a traditional IRA)? If your plan offers a Roth 401(k), it’s wise to put your contributions there because the money will be tax-free after you retire.  It also shields your retirement assets from possible future income-tax rate increases.

How much do I contribute? Look at the current IRS contribution limits and the additional contribution limits of your specific company plan. Try to contribute up to the company match in order to max out your employer’s contributions to your retirement savings. You also should consider how much you can afford to contribute based on your monthly budget and cash flow. Once you’ve contributed up to the match, if you’re able to save more for retirement, review your Roth IRA and other tax-free options.

How should I invest? There are many factors to consider. Each person’s situation is different. Consider your age, risk tolerance, investment timeline, other available retirement assets, fees, taxes, and the amount you’re able to contribute, among other factors.

When do I change my investments? Most employer sponsored retirement plan participants never make changes to their investment choices after they enroll! Broad exposure to low-cost index funds and ETFs across multiple asset classes typically work for most investors to withstand market swings.  However, you shouldn’t disregard your account for years or decades until retirement. Your specific factors, as well as the available investments within your plan, may change with time. Major life events may also necessitate changes in your investment strategy. Get financial advice and think about making annual adjustments to rebalance your allocations, as needed.

Here are four more pieces of solid advice about retirement: start early, be consistent in setting aside money for retirement, make the most of the Roth options when you can, and if you think you need help, find a trusted and knowledgeable person.

Reference: Kiplinger (June 2017) “6 Answers to Your 401(k) Questions”

Please visit our website to learn how we can assist you with your retirement planning.

Do You Know Who Your Beneficiaries Are?

Remember that the named beneficiaries of accounts supersede any instructions in your will, so be careful about selecting the right beneficiaries for accounts and keeping the names up to date.

You may have thought having your will done, means your estate plan is complete.  However, there’s more to it. Different heirs are able to manage different assets, so what assets you leave to who makes a difference. That’s part of a well-thought out estate plan and can make a big difference to your legacy.

Forbes’ recent article, “Pass On Your Assets Wisely: How To Choose The Right Beneficiaries,” examines several common asset types and considerations to be taken when naming beneficiaries.

Life insurance. These proceeds can be paid to the beneficiaries quickly. After proof of death is established, the funds are paid. Think about heirs who may need ready access to funds after you pass. That’s usually not a minor child. However, if you do name a child, you must designate a guardian or place the proceeds in trust. Otherwise, the state may take control and assign a stranger to manage the money on your child’s behalf.

Assets in a Will. When you pass away, your will is going to be probated, and the assets can’t be distributed until the probate process is complete. Because of this, be sure the beneficiary of any property or assets specified in the will, is in a position to wait. You can also create a revocable living trust to hold those assets, so a trustee can distribute assets directly to beneficiaries without waiting to go through probate.

Retirement plans. When you select the beneficiaries for retirement plans, remember that it can result in tax implications. The younger the recipient, the longer their life expectancy, and the more time they will have to withdraw funds from the plans. That means the account can continue to grow tax-deferred. You can also name a trust as the beneficiary of a retirement plan, and the assets in the trust will be protected from creditors. A retirement plan inherited outside of a trust, may not enjoy this protection. In addition, if a beneficiary is young, the trustee can make distributions under conditions you state when you create the trust.

Be mindful of aligning your estate plan with beneficiary selections. If you have a 401(k) plan and name one child as the beneficiary only that named person receive those funds, regardless of any language in your will. It may be better for one person to get funds from a retirement account and another from a life insurance policy, but it is important to be aware of how the two areas must work together.

Reference: Forbes (May 30, 2017) “Pass On Your Assets Wisely: How To Choose The Right Beneficiaries”

Please visit our website to learn more about beneficiary designations. 

Harness the Power of Time to Build Wealth and Don’t Forget to Protect Your Nest Egg

When it comes to saving for retirement, saving early and often is one of the best pieces of advice.

Want to know how to build, protect and grow your retirement savings? One of our favorite sources of practical advice comes from the 70th-anniversary issue of Kiplinger’s Personal Finance. In “5 Time-Tested Tactics to Save for Retirement,” Kiplinger’s editors shared some of their best tips.

Start Now. A 25-year-old who saves $450 a month in a tax-deferred retirement account and earns an average yearly return of 7% will have about $1.1 million at age 65. If he or she waits until age 35 to start saving, they’d have to save $950 a month to reach the same balance by age 65. You should aim to save 15% of your income, including any employer match for your retirement plan.

Take advantage of employer incentives. For your company’s 401(k), you can contribute up to $18,000 ($24,000 for people 50 and older) in 2017 to this pretax account. Your employer may also add another 4% to 6% of your pay,  and possibly more. Try to save 15% of your income, including the company match, from the beginning of your career until the end. Even if you have to cut back for a few years, contribute at least enough to get the full company match, and boost your contributions later to get back on track.

Take stock. Calculate the future value of your current savings and see how much more you’ll need to save to attain your retirement goal.

Plan a plan. Create your retirement budget, with a column for essential costs (housing and food) and another column for discretionary expenses. Factor inflation at 2.4% over the next 20 years, and consider a separate calculation for health care costs which likely will increase at a much higher rate, perhaps as much as 5%. Match your expenses to guaranteed income, like pensions and Social Security, plus the annual amount you plan to withdraw from savings. If you see a gap, you’ll need to spend less or work a bit longer. That may not be a bad thing, since staying in the workforce for a few extra years gives you more time to contribute to your retirement accounts—and you have fewer years to finance when you do retire.

Up your contributions. If you’re 50 or older, you can make catch-up contributions to your IRA and 401(k). This year, you can add $6,000 to your 401(k) above the $18,000 annual contribution limit. That’s a total of $24,000 for the year. You can also save an extra $1,000 in a traditional or Roth IRA beyond the $5,500 annual contribution limit (a total of $6,500 for the year). If you invest $24,000 in a 401(k) every year starting at age 50, you’ll boost your retirement savings by more than $580,000 by the time you’re 65, assuming a return of 6% per year. If you invest $6,500 in your IRA during those years, you could accumulate over $157,000 in your IRA in 15 years.

Especially for the self-employed. In a solo 401(k) plan, you can save as much as $54,000 or $60,000 if you are 50 or older. If you have a SEP IRA, for tax year 2017, you can contribute up to 20% of your net self-employment income–that’s business income minus half of your self-employment tax. The solo 401(k) plan lets you save more, since you are contributing both as an employer and an employee.

Reference: Kiplinger (March 2017) “5 Time-Tested Tactics to Save for Retirement”

To learn more about planning for your retirement and beyond, please visit our website.

 

A Moving Target: Why Target-Date Funds May Not Always Make Sense

The problem with anything tied to time, is that things change. If the investments don’t change with your situation, they can be problematic.

The name alone should be a hint: “target-date funds.” They are widely popular, offered in practically all 401(k) plans, and based on the concept that your investment profile changes as you move through your working lives. For some people, they are a great fit. However, according to a recent article in Kiplinger, “The Trouble with Target-Date Funds in Retirement,” the time to evaluate if target-date funds are the best choice for you, is before you reach retirement.

Target-date funds are frequently the default investment choice in 401(k) plans—so your money’s automatically directed to them, unless you choose otherwise. The Investment Company Institute found that 50% of all 401(k) plan participants had some money stashed in a target-date fund at the end of 2014.

Professional money managers decide where the investments go in target-date funds. They decide how much of the portfolio should be in stocks, bonds, or other assets and these managers choose which funds to buy. They will adjust the holdings to make the portfolio more conservative, as you get older. Each fund family follows what is called a glide path for its series of target-date funds. This path will change the mix in stocks and bonds over time. After these funds hit their target year, some continue to adjust the stock-bond mix—usually for another 10 to 20 years—but some will stop all adjusting. That’s the difference between a target-date series that shifts through retirement and one that shifts to retirement.

The issue for retired investors is that target-date funds may not be nimble enough. Look at these reasons to review your target-date fund holdings when you retire.

Fund has a “to” retirement glide path. Most target-date series follow a “through” retirement glide path. However, if you have a series with a “to” glide path that ends at retirement, you need to assess how the portfolio is split between stocks and bonds, so it lines up with your need for return and your risk tolerance. The basic idea of a target-date series that glides “to” retirement, is that you’ll sell your shares in the fund when you retire and move the money into an IRA. You’ll then have the freedom to invest in other assets. But investors shouldn’t to be too conservative in retirement. It is important to keep some growth to maintain your spending.

A glide path may no longer fit. The stock-bond divide varies among different series of funds throughout the glide path. It is even more so in the post-retirement years. The typical 2015 portfolio has 40% of assets invested in stocks, but the range for all 2015 target-date funds stretches from 15% in stocks to close to 60%. Target-date funds are designed to be one-size-fits-all, but no one truly is actually a one-size-fits-all.

Consider a more tax-efficient withdrawal strategy. You can be strategic about which assets you sell to meet your cash needs, but that’s not an option if you have all your retirement money in a target-date fund. In those funds, the withdrawals are made proportionately, according to the portfolio’s prescribed allocation and across all of the fund’s assets. When it comes to retirement withdrawals, the investor doesn’t have the discretion over where those withdrawals come from.

Target funds may be lacking in diversity. Most target-date funds can be described as “plain vanilla,” with investments divided between stocks, bonds and cash. In a low return environment, you may do better with a custom-designed portfolio that offers more flexibility, including the ability to keep a certain amount of cash in your accounts, or if you are bold with investments, incorporate alternative investments.

One thing is certain: you don’t want too many of your retirement nest eggs in any one fund’s basket. Make sure that the fund is the right fit for you and your retirement timeline.

Reference: Kiplinger (April 7, 2017) “The Trouble with Target-Date Funds in Retirement”

Please visit our website to learn what estate planning strategies best fit your situation and goals.

How Does an IRA Fit into Your Retirement Savings Plan?

The Individual Retirement Account, or IRA, was created specifically to encourage Americans to save for their retirement. This tax savings tool should be part of everyone’s retirement plan.

If you don’t already have an IRA, whether a traditional IRA or a Roth IRA, you are missing out on some real tax savings. A recent article in madison.com, “5 Things You Should Know about IRAs,” gives a great overview of this popular retirement savings vehicle. IRAs are a great way for individuals to save money for retirement at the same time that it provides tax advantages.

There are two main types of IRAs: traditional and Roth. Contributions made to a traditional IRA may be deductible or non-deductible, and all contributions made to a Roth are non-deductible. Both types of IRA accounts allow money to grow tax-deferred for many years. After age 59½, you can start taking qualified distributions. You’ll typically have to pay income tax on withdrawals from a traditional IRA, but withdrawals from a Roth are tax-free. Here’s what you need to know about IRAs:

1. Saving for retirement is a solo job, at least when you’re putting money in a tax-sheltered retirement account. An IRA can only have one owner.
2. IRAs have their own beneficiary designations, so who will inherit an IRA is based on who’s on the account's beneficiary forms—not what’s in a will, trust or any other estate document. Therefore, when you open an IRA, name a beneficiary and remember to review and update the beneficiary designation form regularly, particularly when you have a life event, such as marriage or a child.
3. You have until Tax Day to make your IRA contribution for the last year. If you can't make a lump-sum contribution at the start of every year (giving your money added months to compound), you can spread your contributions over a 15-month period, from January until the following March to help you reach the annual contribution limit each year.
4. You typically must have your own taxable compensation to fund an IRA ( although a working spouse can fund a non-working spouse's IRA.) However, you don't have to use your own money to make your IRA contribution.
5. If over the years you find yourself with a group of IRAs from various jobs, it is considered a savvy move to roll them all into one IRA to improve your ability to manage the money. You’ll still be able to make direct contributions and you’ll cut down on the paperwork.

Retirement arrives before you know it. Be prepared so that you’ll have more flexibility and resources when the time comes!

Reference: madison.com (March 13, 2017) “5 Things You Should Know About IRAs”

Please visit our website to learn more about planning for your retirement and beyond.

What are the Rules about Tax Deductions for IRAs Today?

There’s considerable flexibility about using an IRA or Roth IRA, even if you have a workplace retirement plan in place. Just be careful to follow the rules.

Those with workplace retirement plans are allowed to put money into an IRA (Individual Retirement Account). Whether or not you can take a deduction depends on your income level. For example, if a 23-year-old single woman contributes the maximum $18,000 to her Roth 401(k) at work in 2016, and her employer matched $9,000, is she allowed to make a tax-deductible contribution to an IRA?

Kiplinger’s article, “Deducting an IRA Contribution on Your Tax Return,” reminds us that anyone who participates in a 401(k) or other retirement plan at work is also able to contribute up to $5,500 to an IRA. The IRS gives you until April 18, 2017 to make a 2016 contribution.

However, a contribution to a traditional IRA may or may not be tax-deductible. Because the 23-year-old single in our example, is covered by a retirement plan at work, she is only allowed to deduct her traditional IRA contribution, if her modified adjusted gross income (AGI) for 2016 was less than $71,000 (because she's single). This deductible amount begins to phase out when a person’s income is $61,000 or higher. However, there’s no maximum income limit for deducting traditional IRA contributions, if you aren't covered by a 401(k) or other retirement plan by an employer.

Married individuals covered by a retirement plan at work are allowed to deduct their traditional IRA contributions, if their joint income was less than $118,000 in 2016. The deduction starts to phase out at $98,000. If you weren’t covered by an employer’s retirement plan but your spouse was, your IRA contributions can be tax-deductible, if your joint income in 2016 was less than $194,000 (the deduction amount starts to phase out at $184,000). There's no maximum income limit for making tax-deductible contributions, if neither spouse is covered by a work retirement plan.

Even though the 23-year-old single in our example is eligible to deduct traditional IRA contributions, she may want to contribute to a Roth IRA instead. She can’t deduct Roth IRA contributions (and her Roth 401(k) contributions are also after taxes), but the money grows tax-free for retirement. She can also withdraw her contributions without a penalty or taxes at any time. Since she's young, and her income will likely increase over time and push her into a higher tax bracket, the benefit of tax-free growth in the Roth IRA is likely to be better than the benefit of receiving a tax deduction for traditional IRA contributions now.

Studies have shown that, especially for younger investors, Roth IRAs result in much more after-tax money during retirement than traditional IRAs. If tax rates increase in the future, the Roth will be beneficial, and it has no required minimum distributions (RMDs) after you turn 70 ½.

You’re able to contribute the full $5,500 to a Roth IRA for 2016, if your modified adjusted gross income was less than $117,000 for singles or $184,000 if you’re married filing jointly. The amount you’re able to contribute phases out until your income reaches $132,000 for singles and $194,000 if married filing jointly. The income limits are slightly higher for 2017 contributions.

The most important thing for people just starting out in their careers to keep in mind, is that time is on their side. By starting to save and invest for retirement in their early twenties, they have all of the advantages of building a healthy retirement nest egg over an extended period of time.

Reference: Kiplinger (February 3, 2017) “Deducting an IRA Contribution on Your Tax Return”

 

To learn more about IRAs and planning for your retirement, please visit our website.

 

Your Financial Checklist for 2016 Financials

Before the New Year gets old, follow these five steps to get your financial and legal house in order.

It is not flattering but true: people will spend more time planning their vacations than they do their personal finance or retirement planning, according to Business Insider’s article, “A financial adviser shares a 5-step checklist to complete before the end of 2016.” That’s why many professionals advise taking the time to conduct a review of your financial and legal health. This should include assets, liabilities and estate planning documents. You may have had a lot of changes in the prior year, you may have big plans for 2017, or you may have nothing on the horizon, but the habit of an annual review can provide great insight, help your planning and protect your lifestyle.

Here are some important financial steps to take at the start of 2017.

Take financial inventory. Consider aggregating your accounts and identifying what you have, such as IRAs, bank accounts, and life insurance. You should take an inventory of your debt and determine how you will pay it off in 2017.

Review your estate plan. OK, it’s not that exciting, but it’s important. Don’t wait until this time next year because tragedy can strike at any time. If you fail to plan properly, and something unfortunate happens, your family may be left unprepared. It's critical to have control over what will happen to everything that you leave behind.

Update your beneficiary forms. This is a task that should be reviewed periodically—especially if you've been married or divorced, had children, or retired in recent years. A designated beneficiary on an insurance policy or an IRA has precedence over a will or a trust. As a result, it's important to make adjustments after major life changes.

Make some smart tax moves. You should know how the taxes work on your 401(k)s and IRAs, so take a look to be certain you're saving effectively. The maximum annual contribution to a 401(k) is $18,000 or $24,000 if you're over 50. Therefore, if you've got a holiday bonus, that’s the perfect reason to add to your retirement accounts.

You should also remember that you can gift as much as $14,000 per person annually to as many people as you'd like without a gift tax liability. In addition, with any tax planning for retirement, you might think about converting your retirement money through a Roth IRA conversion ladder. Money transferred from a traditional IRA to a Roth is tax- and penalty-free after paying taxes on the conversion.

Evaluate your path to retirement. Retirement planning is important at every stage of life, so be proactive. If you create a plan, it can hold you accountable. It is important to speak with a qualified estate planning attorney. Don’t just “set it and forget it.” Stay on top of issues and continually monitor the situation.

If you are close to retirement, start having conversations with your estate planning attorney, CPA and financial advisor now about tax planning and expected sources of income. This includes guaranteed income, social security, a pension if have one, and how they will work together into your retirement income plan. Your discussions should include your tax situation, and what, if any, aspects of your estate plan need to change for future tax planning.

Reference: Business Insider (December 9, 2016) “A financial adviser shares a 5-step checklist to complete before the end of 2016”

To learn how your tax situation can impact your estate plan and vice versa, please visit our website.

Collecting Death Benefits from Life Insurance Policies

If you are the beneficiary of someone’s life insurance policy, you should know that there are options as to how the policy funds, known as death benefits, can be distributed.

In most situations, the beneficiary of a life insurance policy does not have to pay income taxes on death benefits, according to a recent article in Forbes, “Are Life Insurance Proceeds Subject to Taxes?”

But depending on your situation, you might want to consider different options for that money that may be more productive in the long term. The insurance company can cut a check, but you can also have the insurer hold on to all or some of the funds and distribute them at a later date or in periodic distributions. If the money is held by the insurer, it will continue to earn interest—and that interest is taxable.

Another option is to transfer those funds to a trust that could control the proceeds of the policy based on the stipulations you set when creating it. However, remember that trust planning can get complicated if you establish “incidents of ownership” in the policy, in other words, if you are controlling the policy in some way. For example, such “incidents” include borrowing against it, using it as collateral or assigning it in a contract. If that happens, the proceeds of the policy might be considered a part of your estate and be subject to estate taxes when you die. Those estate taxes may be delayed if your spouse is the beneficiary, but taxes may be due when he or she passes away.

Also, remember that while you can state in your will that the proceeds of a life insurance policy should go to one of your beneficiaries, only the named beneficiary of the policy gets the funds, overriding whatever the will itself says. When your intentions change, you must contact the life insurance company to update your beneficiary designation. You should also update any 401(k)s, IRAs, or other retirement savings.

To avoid any expensive mistakes, including creating taxable events, speak with an estate planning attorney to make sure that all of your life insurance policies are aligned with the overall goals of your estate plan. These can be complex financial instruments, and the help of an experienced professional will ensure that you reach your ultimate goal: protecting your loved ones.

Reference: Forbes (August 30, 2016) “Are Life Insurance Proceeds Subject to Taxes?”

To learn more about ensuring your life insurance policies reflect the intentions of your estate plan, please visit our website.