Like most people, you are probably doing what you can to save for your retirement.  If you are an employee, your employer may have established a defined contribution plan such as a 401k or 403b plan to which you can contribute a portion of your income each year. As an alternative, or in addition to an employer-sponsored plan, you can contribute funds to an individual retirement account (IRA). If you are already retired you most likely have some funds in a 401k or IRA account accumulated over your working life. The income tax laws look favorably on retirement savings and allow you to defer paying tax on income you contribute to a retirement account and on the account's earnings until the funds are withdrawn.  

Many people have significant assets accumulated in their retirement account. Like any other asset of value, it is important to pay close attention to your retirement account when doing estate planning, to be sure this valuable asset is left to your heirs in the most tax-efficient manner possible.

Here are five facts to know about estate planning for retirement benefits.

1. Double the Tax, Not Double the Fun

The value of your IRA, 401k or other retirement account is part of your taxable "estate." This means the value of that asset will be added to the value of all other assets you own at the time of your death to determine if your estate must pay state and/or federal estate tax at your death.

In addition to estate tax, because income tax has not been paid on the funds in your retirement account, the beneficiary who receives the retirement account after your death will pay income tax on the funds in the account as they are withdrawn by the beneficiary. Amounts withdrawn from the retirement account will be taxed as ordinary income based on the beneficiary's own personal income tax rate.

2. Beneficiary Designations Control All 

When you establish a retirement account you can name a primary beneficiary of the account - the person or organization to receive the funds in the account at your death. If you are married, your spouse must be named as the primary beneficiary of your employer plan unless your spouse agrees that a different beneficiary may be named. In addition, you can name a secondary or contingent beneficiary to receive the funds in the account at your death if your primary beneficiary is not living. You may name one or more people as beneficiaries, in equal or varying percentages. Charities, educational institutions, or other organizations may also be named as beneficiaries of a retirement account. These beneficiary designations control to whom the funds in your retirement account are paid at the time of your death.

It is important to review your beneficiary designations periodically and make changes as necessary.   Life events such as marriage, divorce, the birth of a child, or the death of a family member should all trigger a review of beneficiary designations.

3. Plan to Take Advantage of Income Tax Benefits for your Beneficiaries

Uncle Sam is generous and patient... to a point. Although tax laws allow you to defer the payment of income tax on the funds you contribute to a retirement account, those same laws don't allow this tax deferral to continue indefinitely. The tax laws require you to begin taking withdrawals from a retirement account when you reach a certain age. Similarly, when the owner of a retirement account dies, the tax laws require the beneficiary of that account to start withdrawing and paying income tax on those funds.  How quickly the funds have to be withdrawn, and how much tax must be paid on the funds as they are withdrawn, are key issues to consider when planning for the distribution of your retirement benefits after your death.

There are significant income tax benefits to naming your spouse as the primary beneficiary of your retirement account including the option for the surviving spouse to 'rollover' the deceased spouse's retirement account into the surviving spouse's own IRA, and therefore delay the withdrawal of funds from the IRA until the surviving spouse turns age 70.5.

There are also benefits to naming young beneficiaries like children, grandchildren, or nieces or nephews, as they may have the option to "stretch" the withdrawal of funds from the retirement account over their own life expectancy.   This type of stretch pay-out is a powerful tax-savings strategy, as income tax is paid only on the funds as they are withdrawn, allowing years of tax-deferred growth.

For those who are charitably inclined, naming a qualified charity as the beneficiary of a retirement account will save the income taxes that would otherwise be paid on those funds, as a charitable organization does not pay income tax on the retirement funds it receives.

4. Don't Forget About Planning for Estate Taxes

An important part of estate tax planning is to consider the liquidity of the estate and plan for how estate taxes will be paid without the need to liquidate assets. Planning for taxes on an estate with a large retirement account is important, as having to withdraw funds from the retirement account to pay estate taxes will generate income taxes on the funds that are withdrawn, creating an undesirable tax result.

Leaving retirement benefits to charity is one way to reduce your estate tax burden. Naming a qualified charity as the beneficiary of a retirement account will give your estate an estate tax charitable deduction, allowing those benefits to pass to the charity estate-tax free. If you are planning to leave money to charity at your death, consider the estate and income tax benefits of funding that gift with retirement plan assets.

If you have a large estate or wealthy children, consider naming your grandchildren as beneficiaries of your retirement account, rather than your children. Doing so will allow the retirement plan assets to avoid estate tax at your children's death, and will provide the income tax advantages of an extra-long stretch payout to grandchildren. If you are considering this type of planning, be sure to consult with your attorney about the generation-skipping transfer tax implications of this type of arrangement.

5. Take Time to Learn About Your Retirement Plan

All retirement accounts are not created equal. Although the rules governing IRA accounts are mandated by federal law, the terms of your employer's retirement plan are specific to that plan and very likely different from another employer's plan. For example, your employer's 401k plan may not permit a beneficiary to stretch payment over his or her life expectancy, or may require a beneficiary to withdraw the funds from the retirement account in a lump sum within five years of your death. Other plans may not allow a Trust or a charity to be named as the beneficiary of a retirement plan. Rolling over the retirement funds from the employer's plan to an IRA, either following your retirement or after your death, may give you and your beneficiaries more options.  

An important first step in planning for your retirement benefits is to review your plan's documents with your advisor, determine your planning options, and if necessary determine whether it is possible to move the funds, now or in the future, to allow more flexibility in planning.

For many people, a retirement plan is their largest asset.   Like any other valuable asset, there are significant estate tax implications of owning a large retirement plan. Unlike many valuable assets, there are also significant income tax implications. A good estate plan will include thoughtful and careful planning to ensure that the funds in a retirement plan will be paid to the intended recipients after your death in a way that minimizes both income and estate taxes, and if possible takes advantage of the favorable tax rules applicable to this type of asset.

Because employer retirement plans vary in their provisions, it is important to get individual advice about your retirement plan and your options. As with other planning issues, what works for your neighbor, barber, chiropractor or pet sitter will not necessarily work for you and your retirement account.

Attorney Maria Baler is an estate planning and elder law attorney and a partner with the Dedham law firm of Samuel, Sayward & Baler LLC. She is also a director of the Massachusetts Chapter of the National Academy of Elder Law Attorneys (MassNAELA). For more information, visit www.ssbllc.com or call (781) 461-1020. This article is not intended to provide legal advice or create or imply an attorney-client relationship. No information contained herein is a substitute for a personal consultation with an attorney.