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I have about $500,000 in a 403(b) account. I am writing my will and I do not know whether the money in my 403(b) will be subject to taxes when it is distributed to those I list in my will. Or, will the money just pass directly to those whom I have named?
– Bill
Bill, it’s great that you’re thinking about this in advance. While your heirs may face tax consequences, your 403(b) balance won’t automatically be taxed in full when they receive it. Instead, the tax implications depend on how and when they withdraw the funds. Fortunately, with careful planning, you can help manage their potential tax burden. Let’s break down how your 403(b) assets will pass to your heirs and what they should expect in terms of taxation.
If you’re facing questions about how to manage your wealth or plan your estate, consider speaking with a financial advisor.
Because we are talking about your retirement account and your will, there’s an important distinction to keep in mind: While your will determines how most of your assets are distributed after your death, your 403(b) account allows you to name beneficiaries directly.
This is an extremely important distinction for a couple of reasons:
Even if your will and your 403(b) beneficiary designations conflict, the beneficiaries listed on your account will receive the funds. For example, if your will states that your 403(b) should go to your children, but your account still lists an ex-spouse as the beneficiary, your ex-spouse will inherit the funds. Be sure your beneficiary designations align with your wishes.
If you don’t designate beneficiaries, your 403(b) will be distributed according to your will, which often means going through probate. Probate is a legal process that can be time-consuming and public. By naming beneficiaries on your 403(b), you can help your heirs avoid probate and receive the funds more quickly.
(But if you have additional questions about financial planning and/or estate planning, match with a financial advisor and talk it over.)
As I mentioned, there are tax consequences your heirs need to understand but they aren’t directly related to receiving the funds. Your heirs only incur a tax obligation when they withdraw the money. Think of it as a two-step process.
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Step 1: Your heirs will receive their share from the 403(b). They can choose to leave the money in the account or transfer it to an inherited IRA. If they do either of these, they won’t owe any taxes immediately. If they choose to receive the money outright – such as by depositing it into their savings account – then it’s fully taxable.
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Step 2: If they keep the money in the 403(b) or transfer it to an inherited IRA, they will only owe taxes on money they withdraw, in the year they withdraw it.
