How Do Beneficiaries Receive Their Money?

A beneficiary designation is a legal instruction specifying who will receive assets from an account or policy upon the owner’s death. These designations are a fundamental component of financial planning, determining how specific assets are distributed. Understanding the process of receiving inherited assets is important for a smooth transfer of wealth.

Types of Assets and Beneficiary Designations

Many financial assets allow for direct beneficiary designations, which can help transfer wealth outside of the probate process. Examples include life insurance policies, retirement accounts (such as IRAs, 401(k)s, and 403(b)s), bank accounts with Payable-on-Death (POD) designations, and brokerage accounts with Transfer-on-Death (TOD) registrations. Assets held within a trust are managed by a trustee for the benefit of named beneficiaries, with the trust document dictating distribution terms. For these asset types, individuals typically name a primary beneficiary and a contingent beneficiary who would receive the assets if the primary beneficiary is unable to.

Assets without specific beneficiary designations, such as real estate held solely in the decedent’s name or personal property not in a trust, generally pass through the probate process. This court-supervised procedure verifies the will, if one exists, and oversees asset distribution according to the will’s terms or state law if there is no will. While beneficiary designations override instructions in a will for the specific assets they cover, coordination between all estate planning documents is important.

Claiming Procedures for Different Asset Classes

The process for claiming inherited funds varies depending on the type of asset, but generally involves notifying the financial institution and submitting specific documentation. For life insurance policies, beneficiaries typically contact the insurance company’s claims department and provide policy details. A certified copy of the death certificate is a universally required document for most asset claims, alongside the beneficiary’s identification. Claim forms are provided by the insurer and must be completed accurately.

Life insurance companies generally process claims within 14 to 60 days. For retirement accounts like IRAs and 401(k)s, beneficiaries must contact the plan administrator or custodian and complete specific claim forms, which might include options for how the inherited funds will be distributed.

Claiming funds from Payable-on-Death (POD) bank accounts is often straightforward. The beneficiary typically visits the bank with a certified death certificate and their identification. The bank can facilitate the transfer of funds. For Transfer-on-Death (TOD) brokerage accounts, beneficiaries contact the brokerage firm and provide a death certificate and an application to re-register the securities in their name.

When assets are held in a trust, the trustee is responsible for managing and distributing the assets according to the trust document’s instructions. Beneficiaries should communicate with the trustee to understand the distribution timeline and any conditions. Trustees must distribute assets within a reasonable timeframe. For assets that pass through probate, the executor or court-appointed administrator is responsible for distributing the remaining estate, which can be a lengthy court-supervised process.

Tax Considerations for Beneficiaries

Inheriting assets can have various tax implications that beneficiaries should understand, as these differ based on the asset type. For inherited retirement accounts, such as traditional IRAs and 401(k)s, distributions are generally subject to income tax for the beneficiary. This is because the original contributions and earnings grew tax-deferred. Conversely, inherited Roth IRAs are typically tax-free for beneficiaries, as contributions were made with after-tax money.

The concept of “Income in Respect of a Decedent” (IRD) applies to income the deceased person was entitled to but had not yet received. This can include unpaid salary, commissions, deferred compensation, and taxable distributions from retirement accounts. IRD is subject to income tax for the beneficiary when received, and is also included in the decedent’s estate for federal estate tax purposes, potentially leading to a “double tax” situation. Beneficiaries may be able to claim an income tax deduction for any federal estate tax paid on the IRD.

Federal estate tax is levied on the total value of a deceased person’s estate before it is distributed to heirs. This tax is typically the responsibility of the decedent’s estate, not the beneficiaries, and applies only to estates exceeding a very high exemption threshold, which is adjusted periodically for inflation. Most estates do not reach this threshold, making federal estate tax a concern for only a small percentage of inheritances. In addition to federal taxes, some states impose an inheritance tax, which is paid by the beneficiary directly on the value of the assets they receive.

For non-retirement assets like real estate or stocks, beneficiaries often benefit from a “step-up in basis.” This provision adjusts the asset’s cost basis to its fair market value on the date of the original owner’s death. This means that if the beneficiary sells the asset shortly after inheriting it, any capital gains that accrued during the original owner’s lifetime are generally not taxed to the beneficiary. The beneficiary is only responsible for capital gains tax on any appreciation that occurs after the date of the decedent’s death. Inherited IRAs and other retirement accounts do not receive a step-up in basis.

Distribution Options and Rules

Beneficiaries often have choices regarding how they receive inherited funds, particularly for retirement accounts, which involve specific rules governing distributions. For many assets, beneficiaries can opt for a lump-sum payment or elect to receive payments in installments over time. The choice between a lump sum and installments can have significant tax implications.

The rules for inherited retirement accounts underwent substantial changes with the SECURE Act, particularly impacting non-spouse beneficiaries. For most non-spouse beneficiaries inheriting accounts after 2019, the “10-year rule” generally applies. This rule requires the entire inherited account to be distributed by the end of the 10th calendar year following the original account owner’s death. If the original account owner died on or after their required beginning date (RBD) for taking distributions, the non-spouse beneficiary must also take annual Required Minimum Distributions (RMDs) during years one through nine of the 10-year period, with the remaining balance distributed by the end of year 10.

Certain individuals are classified as “eligible designated beneficiaries” (EDBs) and are exempt from the 10-year rule, retaining the ability to “stretch” distributions over their own life expectancy. This category includes surviving spouses, minor children of the decedent, disabled individuals, chronically ill individuals, and individuals who are not more than 10 years younger than the decedent. EDBs can spread out the tax burden over a longer period.

Surviving spouses have the most flexible options for inherited retirement accounts. They can choose to treat the inherited IRA as their own, rolling it into an existing IRA or opening a new one in their name. This allows them to delay distributions until their own RMD age, or continue tax-deferred growth. Alternatively, a surviving spouse can remain as a beneficiary and take distributions based on their life expectancy or adhere to the 10-year rule.

For inherited annuities, payouts can vary based on the contract terms and the timing of the original owner’s death. If the owner dies before payments begin, the beneficiary often receives a lump sum or can choose to annuitize the remaining value. If the owner dies after payments have started, the beneficiary may continue to receive the remaining payments over a specified period or for their lifetime, depending on the annuity’s structure.