The Pitfall of Retirement Plans and Your Trust

For most people, retirement savings represents a significant portion of their net worth. Many people want to know whether they should make their trust a beneficiary of their IRA, or transfer their trust into their IRA. An IRA is treated very differently from a simple savings account with respect to inheritance, and the general answer is that you not name your trust as the primary beneficiary of your IRA.  

Remember that your revocable living trust, for the purposes of your inheritance, becomes irrevocable upon your death, and assets in irrevocable trusts are generally taxed at a higher rate than if they’re owned by an individual.  

Also, when you reach the age at which you’re subject to a required minimum distribution (RMD), you are required to take mandatory withdrawals from your retirement account over a period of time.  For an inherited IRA, the amount of the RMD is calculated based on the life expectancy of the oldest trust beneficiary. If you have multiple beneficiaries of varying ages, some of the younger beneficiaries may have to take earlier withdrawals and erase the tax benefits of keeping the money in an IRA.  

The tax implications also relate to the length of time assets can stay in the retirement account after death. With individual beneficiaries, the IRS allows for stretched distributions over beneficiaries’ lifetimes, minimizing the tax burden. However, naming a trust as a beneficiary often leads to a shorter distribution period, resulting in larger annual withdrawals and a higher overall tax bill.

Sometimes, it will make sense to name a trust as a beneficiary of a retirement account. For example, if you have minor children, leaving the money in trust can provide safeguards, allowing you to appoint a trustee to manage their inheritance until they reach adulthood. In this case, the benefits outweigh any perceived tax disadvantages.  A trust can be used to provide ongoing financial support for a loved one with special needs, protecting their eligibility for government benefits.

This is ultimately a conversation to have with your accountant, financial planner, and estate planning lawyer like our team at David Austin Law, but given that retirement accounts comprise a significant amount of most Americans’ savings, choosing the right beneficiaries is critical.