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SEVEN REASONS TO NAME A TRUST AS A BENEFICIARY OF A RETIREMENT ACCOUNT

On Saturday, February 27, 2021, I was a guest on financial advisor Rick Foster’s radio show on 660 AM and he asked the question, “When should an IRA go into a trust?” As a result of this often-asked question, I decided to expand upon this with our radio show on 770 AM the following week (click here to listen to podcast).

First, it should be noted that normally when you withdraw from a qualified retirement account, there should be income taxed on the withdrawal (an exception is a direct distribution to a charity). You cannot put your retirement account (IRA, Roth, SEP, etc.) in a trust while you are living. Furthermore, to avoid full income taxation within five years of the owner’s death if a trust is named as a beneficiary of the retirement account (to be a “designated beneficiary” as a see-through, conduit or accumulation trust), here are the four requirements:

  1. The trust must be valid under state law;
  2. The trust must either be irrevocable or become irrevocable upon the owner’s death;
  3. The trust beneficiaries who are beneficiaries with respect to the trust being named as a beneficiary of the qualified retirement account must be identifiable from the trust document; and
  4. The retirement account administrator must receive a copy of the trust or an affidavit by December 31st of the year after the year of the IRA owner’s death.

However, there are some situations where the qualified retirement account owner may name certain types of see-through trusts as a beneficiary to achieve certain protection goals as follows:

  1. Protecting Children from Prior Marriage or Concern that Surviving Spouse will Remarry.

Although a surviving spouse can do a “spousal rollover” so that only required minimum distributions need be made to defer income taxation, a properly structured trust can achieve that goal while making sure the IRA owner’s children (or other desired beneficiaries) receive the remainder of the retirement account at the death of the surviving spouse. If the surviving spouse had been an outright beneficiary, then they could do whatever they want with the retirement account (i.e., the surviving spouse may give it to children from a prior relationship or may give to a subsequent spouse or have a duty to support a subsequent spouse).

  • Protecting Disabled Beneficiary from Losing Public Benefits.

Certain public benefits such as Medicaid and Supplemental Security Income are “means-tested.” In other words, if your assets are too great or if the beneficiary has too much income, then valuable public benefits could be lost. Naming a properly structured special needs trust (it should be an accumulation trust and not a conduit trust) as the beneficiary of retirement accounts will achieve the goals of (a) funds available for the disabled beneficiary without loss of public benefits; and (b) the ability to stretch payments from the retirement account over the lifetime of the disabled beneficiary. If the disabled beneficiary was named as an outright beneficiary, the retirement account would have to be fully distributed within 10 years (as a result of the SECURE Act that became effective January 1, 2020) following the year of the death of the retirement account owner (resulting in earlier taxation and inability for continued tax deferred growth) in addition to losing public benefits. Under certain circumstances, distributions must be made within five (5) years if a trust is not properly drafted.

  • Protection of a Beneficiary who is a Spendthrift or who has an Addiction.

Some beneficiaries (whether they are a spendthrift or have an addiction or for other reasons) will spend the inherited funds from the retirement account almost immediately. A properly structured trust can reduce or protect against that risk.

  • Protection from beneficiaries’ creditors.

Although Texas is one of only a handful of states that gives creditor protection to an inherited IRA, what if your beneficiary has potential creditor issues and lives in one of the great majority of states that does not grant creditor protection to an inherited IRA? A properly structured trust will give that protection.

  • Protection of Grandchildren (from Child’s Spouse remarrying or Giving to Someone Else by Naming Successive Beneficiaries).

Similar to 1. above, the owner of an IRA may want to make sure that grandchildren are beneficiaries of the owner’s IRA after the owner’s child dies (instead of a son-in-law or daughter-in-law who can remarry or name someone else as the beneficiary of the proceeds if they inherit from your child). If your child is an outright beneficiary, they would often name their spouse as a beneficiary of the inherited IRA and thus the IRA owner’s son-in-law or daughter-in-law could do anything they want with the funds after the death of the child of the IRA owner. The trust would control who are successive beneficiaries to eliminate that risk.

  • Protection of a Beneficiary who is a Minor.

Instead of having a minor or someone who is too immature to handle funds, a trust can be utilized to protect the beneficiary. Someone under the age of majority is considered to not have legal capacity under law. The trust can alleviate this issue.  Furthermore, if your child is a minor and is the beneficiary of your IRA, the SECURE Act does permit a stretch (tax deferred growth) until the age of majority is reached when the other rules for distribution would be applicable. Additional planning considerations should be made for larger estates if the beneficiary is a grandchild due to generation-skipping transfer tax rules.

  • Potential Reduction of Estate Tax.

There has been some speculation that the federal estate tax limit (to have no estate tax) can be reduced from the present $11.7 million limit to $3.5 million. Married couples with larger estates often prepare estate plans to either minimize or at least postpone the payment of federal estate tax by using trusts as a shelter (the limit is doubled) and retirement accounts are often one of the larger assets that Americans own at death.

Estate planning often consists of what or how many layers of protection someone desires. See-through trusts can be used for protection if one or more issues above are a concern.

If interested in learning more about this article or other estate planning, Medicaid and public benefits planning, probate, etc., attend one of our free upcoming virtual Estate Planning Essentials workshops by clicking here or calling 214-720-0102.  We make it simple to attend and it is without obligation.

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