What Happens to Your Retirement Money When You Die?

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It's still true that when it comes to your money, "you can't take it with you" once you've passed away. If you still have loved ones who depend on you, or if you want to leave an inheritance, though, it does matter what happens to your money after you pass.

When you boil it down to its essence, you really have three kinds of financial tools at your disposal:

Those that cease to exist once you've passed.
Those that will last as long as either you or your spouse are alive.
Those that can be passed on to others.

Understanding what falls into each bucket can help you make better decisions on how to invest for and during your retirement.

Money that stops when you and/or your spouse passes If you've ever looked into buying an annuity, or if you have a pension, you've probably noticed that they offer different payments based on how you choose to take your payment. If you accept "single life" payments, you'll generally get a higher payment than if you accept the "joint and survivor" option. The downside is that with the single life payment option, the money stops getting paid once you pass away, while the joint and survivor option lasts as long as either you or your spouse are alive.

Either way, death typically ends pension and annuity payments -- either your death or the second death between you and your spouse.

Social Security behaves a bit differently, but its benefits still have a limited lifespan. When alive, your benefit amount is based on either your own earnings record or half the benefit based on your spouse's earnings record. When one of you passes away, the survivor gets the larger of the two benefits (subject to limits based on age), and children under age 18 get up to 75% of the deceased parent's benefits.

The big benefit of pensions, annuities, and Social Security is that they can pay out at a higher rate based on your initial account level than you would likely be able to sustainably withdraw on your own. The downside of that benefit, though is that one of the ways they achieve those higher payouts is by keeping what would have been the balance in the account when the payments stop. That leaves nothing long term for your heirs, which might be OK, but it might not be what you were hoping your legacy to be.

Money that can last Investments in your 401(k), IRA, or standard brokerage account can be passed on to your children or donated to a charity of your choosing at their full value through your will. You can even pass up to $5.4 million directly to your grandchildren before the federal Generation Skipping Transfer Tax kicks in. While you can pass that money on, it does get treated differently depending on where it's located.

Investments in a standard brokerage account get a "step up" in basis to their value as of the date of death, or sometimes to an alternate date six months after death. In other words, if you own stock that you paid $1,000 for several decades ago that winds up being worth $100,000 when you pass away, whomever you willed that stock to will pay taxes on it as if he or she paid $100,000 for those shares.

Investments in a traditional IRA or 401(k)retain most of their character as an IRA or 401(k), but they generally must be withdrawn from those accounts over time. The timing of those withdrawals is different depending on whether your spouse inherits it or another person (such as your child) does. Your spouse typically has options to treat the money similarly to as if it were his or her own. Any other recipient has to take distributions based on either a five-year timeline or his or her expected lifespan.

Investments in a Roth IRA or 401(k)are treated similarly to the way traditional IRAs or 401(k)s are treated, with a key difference being that inherited Roth-style accounts may allow for tax-free withdrawals. This ability makes Roth-style accounts a powerful estate-planning tool, even though they do require you to pay taxes on your money at the time of contribution or Roth conversion.

Cover your retirement -- then take care of your heirs What happens to your money after you pass away is important for those you leave behind, but it's a secondary concern behind having access to the money you need to cover your costs in your retirement. You can't take the money with you, and you should certainly enjoy the fruits of your labor during your golden years.

Still, by understanding what happens to the money you do leave behind, it may help you decide on a different funding or withdrawal strategy for your retirement assets. That way, you can best position yourself to use what you need and best help your heirs once you've passed.

The article What Happens to Your Retirement Money When You Die? originally appeared on Fool.com.

Chuck Saletta has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.