When you operate a self-directed Solo 401(k) plan, being mindful of the beneficiaries who will inherit your plan is important.
Choosing who to name as beneficiaries for your plan and how to make your designations can be simple or complex, depending on your situation and goals.
Beneficiary rules changed with the SECURE Act effective January 1, 2020. If you have not reviewed your plan beneficiaries in some time, it would be prudent to revisit the topic.
It is always a good idea to speak with your licensed estate planning counsel about 401(k) beneficiary designations. Following are some tips to help guide that conversation.
How are Beneficiaries Designated?
When you implement your Solo 401(k) plan, it is important to name at least one primary beneficiary. The plan documents include a beneficiary designation form for this purpose.
You can add or change beneficiary designations at any time simply by completing a new beneficiary designation form.
It is a good idea to keep a copy of the 401(k) beneficiary designation with your other estate planning documents.
Primary and Contingent Beneficiaries
You can name both primary and contingent beneficiaries. A primary beneficiary will inherit their allocated share of the 401(k) at your passing. If no primary beneficiary is available, then the contingent beneficiary or beneficiaries will receive plan benefits.
When you assign beneficiaries, you must allocate 100% primary beneficial interest. You can designate one or more beneficiaries as primary, so long as the allocation adds up to 100%.
Naming contingent beneficiaries is optional. Just like with the primary designation you must allocate 100% of the account value across the named parties in the contingent position.
Naming Your Spouse
Most married plan participants list their spouse as the primary beneficiary for their Solo 401(k).
If your spouse will continue the business that sponsors the Solo 401(k), they can simply move the existing account into their name. They can alternately rollover to an IRA in their name.
In any spousal inheritance, the plan funds are treated as theirs and subject to all the same rules and timelines for distributions as if the account was initially opened in their name.
Alternately, a spouse can choose to be treated as a beneficiary. This will allow the spouse to take distributions from the account without a 10% penalty for early distribution if they are under age 59 ½. This beneficiary election requires an IRA rollover, and subjects the account to Required Minimum Distributions using the spouse’s life expectancy table. A beneficiary IRA of this type cannot be consolidated with other retirement plans in the spouse’s name.
Naming a Non-Spouse
You can name any individual or entity as a beneficiary for your plan. Depending on your marital status, family structure, and goals, you might choose to name one of more of the following:
- A Trust
- Educational institutions
- Charitable organizations
Rules for the timing of distributions will vary based on the type of beneficiary.
Community Property States
If you live in a community property state and are married, you must obtain your spouse’s written consent if you wish to name anyone other than your spouse to receive all or part of the primary beneficial share.
Community property states include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.
Trust as Beneficiary
Naming a trust as beneficiary for your IRA can have several advantages in certain scenarios.
If you have beneficiaries who are minors or otherwise unable to care for themselves, using a trust is a good way to ensure your instructions for their care are followed.
A trust allows you control contingent beneficiaries over time. If you were to directly name a second spouse as your beneficiary, they could then choose to change the designations on the account and cut out children from a first marriage you may wish to leave funds to. A properly implemented trust will eliminate such a situation.
Taxation can occur at the trust level or flow to the receiving beneficiary depending on trust design.
Proper use of a trust beneficiary can be complex. Be sure to utilize qualified counsel if you choose a trust beneficiary.
If you have a trust named as beneficiary on your Solo 401(k), it would be a good idea to ensure it is compatible with the changes created by the SECURE Act.
Different Beneficiary Types & Distribution Rules
Who you name as beneficiary can determine how quickly the account needs to be distributed.
A non-named beneficiary such as an estate, charity, or trust that does not specifically name individual beneficiaries will need to distribute the entire plan value within a 5-year period if the account holder was under the age of 72 when they passed. If the plan participant was age 72 or older at the time of death, the life expectancy table of the owner is used to determine the required minimum distribution amount each year.
An “Eligible Designated Beneficiary” will be able to distribute the account over time. The longer of the beneficiary’s or the account holder’s life expectancy table will be used to determine the minimum required distribution each year. Eligible Designated Beneficiaries include:
- The owner’s spouse if electing beneficiary status.
- Owner’s children under the age of 18, though they must then fully distribute the IRA by the age of 28 – ten years from reaching majority.
- A disabled or chronically ill individual
- Any other individual who is not more than 10 years younger than the original IRA owner
A designated individual who is not such an Eligible Beneficiary must distribute the account in full by the end of the 10th year following the original account holder’s death.
Keep Designations Up to Date
A regular review of beneficiary designations is important. We recommend a mid-year financial review in the summer when other tax matters are in the background. This is a good time to ensure plan beneficiary designations are in good order. Events such as the death of a beneficiary or a name change associated with marriage may require an update to your beneficiary designation form.
Be Sure your Beneficiaries Know about your Solo 401(k)
The investment holdings of a self-directed Solo 401(k) are often unique, and there is no 3rd party bank or brokerage that tracks the details or provides a statement. It is a good idea to produce your own statement periodically.
It is therefore important that you maintain up to date records about your plan’s investments in a place known to the person who you have chosen to administer your affairs.