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Who Gets Your 401(K) When You Die?

It is important to think ahead. Many people spend decades saving for retirement with no thought of what might happen to their loved ones if they were to pass early. Some assets are bequeathed via your Last Will and Testament and others, like a 401(K), go to designated beneficiaries. You are asked to make that designation when the account is set up, however, you can also choose to leave additional instructions for the money in your Will.

Let’s take a closer look at 401(K) accounts, how to set one up, and how to pass the money on to your beneficiaries.

What is a 401(k)?

A 401(k) is a savings account designed specifically for retirement in later years. Since it is a “qualified” retirement plan between an employer and an employee, a 401(k) receives special tax benefits that work to the employee’s advantage. Over time, an employee may invest a certain percentage of his/her income in a 401(k), with their employer matching their investment up to a certain point. The purpose of a 401(k) is to benefit everyone throughout the years-long investment process, benefitting the employee the most at the end.

How Does a 401(k) Work?

Generally speaking, a 401(k) plan is included in your work benefits. When you begin your job, you work out a plan with your employer. Based on this plan, a fixed amount of your annual income is placed in your 401(k) account. Your employer may also place a fixed amount into your account. A 401(k) is a defined contribution plan, which means that it is tax-deferred. In other words, you will not pay income tax until withdrawal. If you withdraw early (before age 59 and ½), there will be a tax penalty. You may withdraw your money with no penalty when any of the following occurs:

  • The plan is terminated.
  • You die or become physically disabled.
  • You experience a situation specified in the plan as being free from penalty.
  • Retirement or you leave your job.

Notice, that there is no penalty for those who inherit your 401(k) even if you or they are under the official age of 59 and 1/2, required for no-penalty withdrawal. The money will still be subject to income tax and possible inheritance taxes.

How Much Money Should You Put in a 401(k)?

Of course, the exact amount of money you should invest in a 401(k) account depends on your exact situation. Are you married? Where do you live? How expensive is your taste? Your answers to these questions determine whether you need more or less money.

Experts recommend that you save money based on one of the following plans.

1. 10-Year Income Plan

The 10-year plan says that you should save 10x the amount of money you currently make per year. If you make $150,000 annually, then you should have 1.5 million saved for your retirement.

2. Million Dollar Plan

Many individuals suggest that a flat rate of a million dollars is more than enough for anyone to live comfortably in retirement. While in many cases, a million is enough, make sure you consider every avenue of your life before deciding that is all you need.

3. 80% Income Plan

An 80% income plan says that a healthy retirement requires 80% of your annual income for every year after you retire. Of course, no one knows exactly how long they will live after retirement.

Remember to take your monthly expenses into account, including car payments or mortgages. Work out a detailed budget to ensure you don’t end up in a rough place after you retire.

What Happens to Your 401(k) if You Pass Away?

It is important to note that your 401(k) is separate from your will. Many people mistakenly assume that designating a 401(k) beneficiary in their will takes care of everything. Actually, you must assign a beneficiary specifically to your 401(k). If your beneficiary dies, then your 401(k) will be distributed among other beneficiaries as determined by your judge or power of attorney.

Make sure you get all of your end-of-life documents squared away (including your Affidavit) so that your heirs will receive everything you want them to have.

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