A trust is used to keep your home and other assets safe from probate and distribute your non-tax-deferred assets. Your 401(k) distribution on the other hand is governed by the beneficiary form you probably filled out years ago when setting up your retirement plan.
In California, even if you have a will and/or a trust, the beneficiary designation form still controls who receives your 401(k) when you die. While your most recent estate planning documents may distribute your assets in one way, an outdated 401(k) beneficiary form could send a substantial amount of your assets to someone whom you no longer wish to leave property.
The most common mistakes involve failing to update beneficiary forms after there has been a major life change. Many people initially list parents or siblings as their beneficiaries and then forget to update the forms after they get married or have children. Others will have a long term significant other as the beneficiary and then neglect to remove them after the relationship ends.
Another potential pitfall arises if one of your beneficiaries passes away before you do. Similar to joint-tenancy, most beneficiary forms operate so that a beneficiary must survive to inherit or their children are cut out. This can result in disinheriting branches of your family if the named beneficiary predeceases you. As an example, say your four children are listed as your 401(k) beneficiaries and one of them passes away, leaving three of their own children. If you then pass away, your remaining three children will each receive one third of the 401(k) assets, effectively cutting out three of your grandchildren. This is contrary to what most people specify in a trust.
Most 401(k) beneficiary forms do not allow for “contingent beneficiary” options to avoid the above situation. To avoid this result, you can list a trust as your beneficiary which will then distribute the assets according to your wishes. There are, however, complex tax considerations to these decisions that exceed the scope of this particular article.
The most important takeaway is that you revisit your 401(k) beneficiary forms and remove anyone who you clearly do not want to inherit your assets. As always, please consult appropriate advisors before making major changes.