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Trusts and Retirement Accounts

| September 12, 2018
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Trusts and Retirement Accounts

Retirement accounts, IRAs, 401(k)s, and the like, and revocable living trusts can avoid the cost and time of probate court. Whether or not to place retirements accounts in living trusts is an entirely different question.  The answer is NO.  However, using a trust as beneficiary of IRAs and other retirement accounts can avoid nasty tax and probate court surprises. Again, if done correctly, beneficiaries can stretch out IRA distributions over their life expectancy.

Any individual and/or non-individual (charity, estate, or trust) can be a named beneficiary. If Retirement account assets are moved into the trust, rather than being named as beneficiary, then it is deemed by the IRS that a distribution has occurred, and the entire amount is subject to ordinary income tax in the year the distribution was made.

Retirement accounts use beneficial documents to determine where assets will pass after the death of the grantor.  The beneficiary designation on this document will override that of any designation contained in a will or trust (also life insurance and annuities).  It is very important to review your beneficiary designations periodically to make sure they still coincide with your final wishes. 

For example: Your new spouse is the updated beneficiary of the trust or will, but the ex-spouse was never removed as beneficiary on your 401(k).  At the time of your passing the ex-spouse will still inherit the 401(k) assets.

So why would the owner of an IRA want or need to name a trust, rather than a person, as his or her beneficiary?

It can provide for a beneficiary with special needs by maintaining eligibility for qualification of government benefits.  It can protect inheritances for children and grandchildren from the courts, creditors, spouses, divorce proceedings, and irresponsible spending. The primary reason is to exert control over post-death distributions, thus limiting access to inherited assets. Naming a trust as beneficiary will give you maximum control because the distributions will be paid not to an individual, but into a trust that contains your written instructions stating who will receive this money and when. After you die, distributions from the inherited IRA will be based on the life expectancy of the oldest beneficiary of the trust.  

To gain the maximum stretch option of distributing the account, the trust needs to possess specific terms such as "pass through" and "designated beneficiary."  Will it be a conduit trust or an accumulation trust? The trust must also meet these specific conditions.

  • The trust is valid under state law.
  • The trust is irrevocable or will, by its terms, become irrevocable upon the death of the IRA owner.
  • The beneficiaries of the trust are identifiable.
  • A copy of the trust documents are provided to the IRA custodian by Oct. 31 of the year immediately following the year in which the IRA owner died.

 If a trust does not contain provisions for inheriting an IRA or cannot meet the conditions, it should be rewritten, or individuals should be named as beneficiaries instead.

If the goal is to preserve the IRA benefits, tax deferral, spousal rollover, and stretch, for as long as possible then consider naming your spouse as the primary beneficiary and the trust as contingent beneficiary. If a spouse is going to be the primary beneficiary of the IRA assets, it can be more advantageous to younger children if the IRA is initially passed on as a spousal rollover. The IRS allows spouses to roll these inherited retirement assets into their own IRAs.  If they are not more than 10 years younger, the surviving spouse may use their date of birth in calculating RMDs and add younger heirs as beneficiaries.  After the surviving spouse dies, it can be left to younger heirs, using their date of birth to calculate the RMDs. This preserves the tax benefit and assets for as long as possible. If the trust is the beneficiary, the age of the oldest beneficiary is used to set the life expectancy on which the required minimum distributions (RMDs) from the inherited IRA will be based.

The bottom line is, do not put retirement accounts into living trusts.  There is a time and place to utilize a trust as a beneficiary.  As I have pointed out, this is a very complex and complicated subject.  I’ve barely scratched the surface. When considering your options, it is best to solicit the advice of knowledgeable professionals.  Consult with and Estate attorney, your financial adviser, and tax professional.

This article is not intended to be considered legal or tax advice.  The information presented was collected from multiple resources believed to be true and accurate.  The presentation of this information is incidental to my profession as a licensed financial adviser.

Securities and Advisory services provided by Cetera Advisors, LLC. Member FINRA/SIPC. Cetera is under separate ownership from any other named entity.

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