As the owner of a Solo 401k plan, you are the administrator as well as the trustee of your plan. This means you have total control over the plan. Not only do you decide where your retirement savings are invested, but documenting your Solo 401k beneficiaries that will inherit your plan is also important.
Among different retirement accounts, naming Solo 401k beneficiaries is especially important. Without a named beneficiary, the account could end up in probate and may not be distributed according to your wishes. To help you plan for the distribution of your Solo 401k, here we cover how to designate a primary beneficiary, a contingent beneficiary, and the tax implications.
You may also be interested in the article “Succession Planning and the Solo 401k.”
The Basics of Assigning 401k Beneficiaries
When you open a Solo 401k, you want to designate primary and contingent 401k beneficiaries by filling out and submitting a beneficiary designation form. Determining who will be your Solo 401k beneficiary is a personal decision based on your situation and financial goals. You can have multiple primary and contingent beneficiaries. However, if you are married, federal law automatically assigns your spouse as your primary beneficiary. You must obtain spousal consent to name someone else as your primary Solo 401k beneficiary.
You are not limited to a single primary beneficiary and a single contingent beneficiary. Many Solo 401k owners have multiples of both. Your primary Solo 401k beneficiary may not survive you or may decline to accept your assets which is why it’s important to have contingent beneficiaries. When you have multiple beneficiaries, it becomes critical to specify the percentage that each beneficiary will receive.
Life happens, and situations change. This makes it a good habit to review your Solo 401k beneficiaries at least annually. Your mix of assets and their value will change over time. This can make a difference in who you want as beneficiaries and the percentages you want to be distributed to each. Besides an annual review, it’s important to review your 401k beneficiaries during a major life event (marriage, divorce, birth or adoption of a child, death, etc.). You can add or change Solo 401k beneficiary designations at any time simply by completing a new beneficiary designation form.
It’s always a good idea to keep a copy of the Solo 401k beneficiary designation with your other estate planning documents.
Primary 401k Beneficiaries: Your Spouse
Naming a spouse as the primary Solo 401k beneficiary is the most common designation for account owners. If the business sponsoring the Solo 401k will continue operating, the spouse can simply move the existing account into their name. But the spouse does have multiple options. If he or she is self-employed, they could roll over the Solo 401k funds to their own Solo 401k or transfer to another qualified plan. Alternatively, they can roll over to an IRA in their name or an inherited IRA (AKA – beneficiary IRA). The spouse can also take a full distribution at the time of the Solo 401k account owner’s death. However, different rules apply depending on which option is selected.
If the spouse continues operating the business in their name, rolls it over into an existing Solo 401k in their name, or transfers to another qualified plan, the rule for that particular plan should apply. If a spouse chooses an inherited IRA, this can 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.
Primary 401k Beneficiaries: Your Children
Unlike your spouse, children do not have the option to transfer the Solo 401k inheritance into their own retirement account that provides continuing tax favorable treatment. Generally, children will be required to begin taking required minimum distributions (RMDs) soon after your death and pay the taxes on those distributions. Alternatively, the child might have the option to remove the assets from the Solo 401k and place them in a beneficiary IRA. In that case, your age at the time of your passing plays a key role.
Parent’s age was 72 or more. If you were over the age of 72, your RMDs would have already begun. In this case, the child can continue taking RMDs over the period of the deceased parent’s life expectancy, or her/his own, whichever is the longer period. They can take larger distributions, but that defeats the purpose of the tax-deferral that continues to compound the money as long as it remains in a retirement account.
Parent’s age was less than 72. This is about leaving the money in the Solo 401k. After reading this section, read the section below about the beneficiary IRA which may be a better option. In neither case is the child allowed to treat the Solo 401k funds as their own retirement funds with tax advantages. The child must receive all money in the plan within five years of December 31, the year of the parent’s death. This does allow the child to vary the withdrawal amounts, which might allow her/him to withdraw the majority of the money in a year when she’s taxed at a relatively low rate. Alternatively, the plan might allow the child to receive the plan’s RMD according to her own IRS life expectancy.
The Beneficiary IRA
The beneficiary IRA is an option for both the spouse and children of a deceased Solo 401k account owner. However, different rules apply.
As a Solo 401k beneficiary, a spouse can transfer it to a beneficiary IRA. The special privilege of the spouse is that they can treat the account as their own by retitling the account in his own name. As such, the spouse beneficiary is allowed to make contributions, take distributions, roll over assets, and otherwise treat the account as if he had always owned it.
A child of the deceased (or any other non-spousal beneficiary) cannot treat an inherited IRA as their own. No contributions can be made to this type of inherited IRA, and the account cannot be rolled over into another IRA. Importantly, distributions from these IRAs must begin immediately.
The amount of the RMD depends on whether the deceased had already begun taking their own RMDs. If so, then the beneficiary can either continue taking distributions based on the life expectancy of the original account owner, or they can consult the IRS life expectancy tables to determine distributions based on their own life expectancy. If the owner has not yet begun taking RMDs, then the beneficiary can take distributions based on his life expectancy only.
Special Needs Children as the 401K Beneficiary
If you have a child with special needs, your first thought is probably to leave a large portion of your Solo 401k to continue supporting them for the remainder of their lives. Often, this is not the best solution. Most children with special needs receive some type of government benefits through Medicaid, Social Security, and other programs. They continue to use these benefits for the rest of their lives. Nearly all government benefits programs have income or asset eligibility requirements. This means that your child cannot have income, assets, or both that exceed a certain dollar amount. If they do, your child’s benefits will end.
Instead of leaving the Solo 401k directly to your child with special needs, you should consider setting up a type of trust called a special needs trust (SNT). When you leave money to a 3rd party SNT that has your child listed as the trust beneficiary, it does not count toward your child’s income or assets for benefits eligibility. Your child and his or her caregivers can still use money from the trust to pay for needs.
By placing some money in trust during your lifetime and/or leaving an inheritance to the SNT, you can protect your child long into the future. When doing so, you need to be aware of special tax laws regarding how much of the money inherited by the SNT is taxed each year which is dependent upon the language of the SNT itself. That makes it important to engage an experienced special needs planning attorney to draft your SNT.
Inherited Solo 401ks and Minor Children
Minor children under age 18 or 21 in some states are another time when it probably isn’t a good idea to directly name them as a Solo 401k beneficiary.
When a minor is listed as the Solo 401k beneficiary, your retirement account will likely be distributed to a court-appointed custodian upon your death. This court-appointed custodian will be in charge of managing the funds (often for a fee) until the age of majority. If you want your child to inherit your Solo 401k, you should consider setting up a trust to receive the assets instead.
You can then name a trustee to manage the account until your child comes of age. By doing so, you get to choose not only who manages your child’s money, but within the trust’s terms, you can stipulate how and when the account’s funds should be distributed and used, which can help them from being lost or misspent.
Contingent Solo 401k Beneficiaries
A contingent Solo 401k beneficiary will not necessarily receive any of the assets from your retirement account. They are a “second-string” beneficiary who more or less waits in the wings, just in case. A contingent beneficiary only receives the account if the primary beneficiary can’t or won’t accept it.
Examples of when the contingent beneficiary will receive your Solo 401k inheritance include if your first beneficiary can’t be found, declines the gift, isn’t legally able to accept it or dies before you do.
The primary reason for having a contingent Solo 401k beneficiary is so that your assets go where you want them to go and do not end up in probate. A typical example might be that you name your spouse as the primary beneficiary of 100% of an account. Your two adult children could then receive 50% each as contingent beneficiaries if your spouse dies before you do. However, a contingent beneficiary doesn’t have to be a family member or even a person. Many Solo 401k owners choose charities or nonprofits to be the contingent Solo 401k beneficiary. You will want to talk to a tax professional about the best way to name a charity or nonprofit. The point is that you can divide your assets up any way you choose.
Keep Your Solo 401k Beneficiaries in the Know
One of the big strengths of a Solo 401k is the ability to hold wealth-building alternative assets. Another is that you are in full control of your finances. These also make a Solo 401k unique because there isn’t usually a 3rd party bank or brokerage keeping detailed records of your assets and accounts. You need to do this yourself or arrange for someone to do it on your behalf. This should include periodically producing a professional financial statement detailing your assets. When your Solo 401k invests in real estate, private placements, cryptocurrency, and other alternative assets, you might be the only person who knows what the plan holds. That makes it all the more important to 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.
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