Retirement Assets in Trust – Pros and Pitfalls

If you have retirement assets, it is important to have a carefully considered plan in place for the disposition of those assets at death, which may involve changes to the beneficiary designation and/or directing those assets into a trust.  Beware though, since ensuring the transfer goes smoothly requires careful planning.

Now more than ever before, a substantial portion of the wealth of Americans is comprised of tax deferred retirement accounts such as traditional IRA’s, 401(k)s and 403(b)s.   In general, receipt of inherited assets does not trigger income taxes, however, a major exception is retirement assets.  Therefore, in dealing with retirement accounts, the goal should be to allow the taxpayer’s estate beneficiaries to defer the tax as long as possible.  This raises a number of estate planning questions including who should be the primary and contingent beneficiaries of the retirement accounts, how long can the beneficiary defer withdrawals and whether there are compelling reasons to name a trust as beneficiary.

While it often makes most sense to leave the taxpayer’s spouse as primary beneficiary on retirement accounts to preserve greater options and maximum flexibility including the spousal roll-over, a trust can be named as a designated beneficiary and at the same time maintain the same post-death options the beneficiaries would have if they were named as individual beneficiaries.  These individuals will generally have the ability to calculate post-death distributions using the life expectancy method thereby stretching distributions over many years.

Naming a trust as the contingent beneficiary can have numerous advantages.    When someone names an individual directly as beneficiary of an IRA or retirement account, that individual will be free to do what they please with the inherited funds, including withdrawing the funds in one lump sum with a huge tax penalty.  One can avoid this and retain control over the funds after death by establishing a trust for the benefit of the beneficiary so they receive the benefit of the funds but at the same time subject to controls and conditions that the original account holder can dictate.  Holding funds in trust can also avoid the funds being attached by the beneficiaries’ creditors.  Trusts also allow the retirement accounts to be directed to a credit shelter or by-pass trust to reduce estate taxes which would not be available with an outright transfer.

To avail oneself of these benefits, there are a number of rules that must be followed including establishing a properly drafted trust and properly designating the trust as beneficiary of the retirement accounts if that is desired.   It behooves one to retain experienced legal counsel in this area because failure to follow these rules can potentially have devastating income tax consequences.