Employing a trust is a wonderful technique to avoid probate, and control your estate beyond the grave. One consideration, prior to drafting a trust, is whether or not to name the trust as a beneficiary for a retirement plan, such as a 401(k), 403(b), IRA, or Roth IRA, and if so, how to properly structure the trust. Although retirement plans achieve the objective of avoiding probate through title if living beneficiaries are named, there are some benefits to naming a trust as a beneficiary. See below for a few advantages and disadvantages of naming a trust as the beneficiary of a retirement plan.
Controlling Distributions of Inheritors: If you are concerned about a beneficiary’s financial decision making, naming a trust as the beneficiary of a retirement plan could create a buffer between an inheritor and the retirement account.
Employing professional investment management: If you do not trust your inheritors to make good investment decisions, naming a trust as the beneficiary could remove the burden of making these decisions from the inheritors.
Ease of updating estate plan: If a trust is named as a primary beneficiary of a retirement plan, updating your beneficiaries can be done by amending one document. If your retirement plan has individual beneficiaries named, you will have to update the beneficiary designations for each retirement account, leaving some room for an error in oversight.
Potential loss of maximum income tax deferral: When a non-spouse individual inherits a retirement account, they have the option of stretching their required minimum distributions (RMDs) over their life expectancy. This can create extra years and of tax-deferred growth in a traditional IRA or tax-free growth in a Roth IRA.
If the trust does not meet certain requirements, the retirement accounts may have to be withdrawn over a period as short as 5 years, depending on the age of the decedent, which would create a loss of income tax deferral for inheritors.
Administration, management, and room for error: As mentioned above, there are ways to maintain the “stretch distribution” characteristics for beneficiaries by using a trust. This can be done by using a trust that meets “see through” provisions as stipulated in Treasury Regulation 1.401(a)(9)-4, Q&A-5. The below bullet points outline the “see through” requirements:
Without getting into the details of these requirements, they can create administration complexity, and room for error, which could cost inheritors thousands of dollars of additional taxes, and legal expenses.
Because there are even more considerations in determining whether to name a trust as a beneficiary of a retirement plan, it is important to work with a qualified attorney and financial advisor to determine which strategy meets your goals taking into account your unique circumstances.
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