Retirement accounts can be a great way to ensure that you have a robust nest egg as you age, and if you happen to pass away with something left on the account, it will go to your loved ones. But which ones? That’s where assigning a retirement beneficiary to your various assets and accounts becomes important.
IRAs and other retirement plans allow you to designate primary beneficiaries and contingency beneficiaries (should your primary beneficiaries pass away). Hence, anything leftover in the account goes directly to your loved ones without fuss or muss, without major interference, and probate. But you have an alternative option to simply designating a person as your beneficiary – you can, if you so choose, designate a trust as your retirement beneficiary.
Unlike simply funding a trust with your IRA assets, designating a trust as a retirement beneficiary allows you to control how your wealth is distributed or even used after death. It limits access to the inheritance and allows you to determine what should be done with your IRA assets once you are gone.
Beneficiaries to a retirement account, or any other account for that matter, typically include individuals and trusts (although there are other options). When it comes to retirement accounts, spouses and children are most often named as beneficiaries. This makes sense in most cases, but there are certain ramifications to consider.
Life insurance policies and retirement accounts are examples of accounts that are commonly set up with beneficiaries ultimately in mind – while it’s clear that retirement accounts exist to help create robust savings for when you retire, it’s often assumed that a portion of your account will go to your loved ones when you pass away. For that, it is important to name the right people.
If you pass away without naming a retirement beneficiary, then the assets will flow into your estate and become subject to the probate process, and depending on the state you are in and the size of your estate, there may be estate taxes to consider as well. It is much easier and practical to name beneficiaries directly. But who to name?
Family is the most obvious choice, but other choices include charities, institutions, or friends. In general, spouses are the most economical choice because they do not have to take mandatory taxable payouts, depending on their age as well. Your tax advisor can tell you more about how taxes function when investing in your retirement and eventually passing on your assets to your family.
If you choose to make friends or younger relatives beneficiaries, it’s important to remember that this may force them to pay estate taxes on their estates, should the inheritance be large enough. Be sure to discuss inheritance matters with your potential heirs to ensure that they have the time needed to plan accordingly.
Another ramification is that 401(k)s, IRAs, and most other retirement plans require beneficiaries to take on the entirety of the assets within the account in a lump sum payment, subjecting them to the income taxes on the full amount. The alternative is taking annual taxable distributions within certain set limits.
If you’ve named children as your contingency beneficiaries and they stand to inherit the entirety of your retirement account before they become adults, they will not be able to take on the inheritance, which can create financial and legal issues as a separate entity must be set up to properly ensure that the funds are managed until the designated beneficiaries are of age.
A final problem is how best to distribute your assets to a beneficiary who lacks the ability to take care of themselves due to previous reckless behavior financially, a financial problem, or mental disabilities. Setting up a trust as a beneficiary can fix many of these issues. Trusts are designed so the grantors can tune the agreement in any way they need, allowing a great degree of control over many assets even long after the grantor has passed away.
A trust is an agreement between the trust grantor, the designated trustee, and the beneficiaries. Trusts are very malleable and can be used to suit many different purposes. Revocable trusts ensure the most control, but anything funded into a revocable trust is still considered among the grantor’s assets until they pass away. Irrevocable trusts offer less control and access to the assets after being completely set up yet offer greater asset protection for tax and creditor purposes.
Some examples of trusts include charitable trusts, special needs trusts, and spendthrift trusts, to name a few. These trusts illustrate just a few ways in which assets could be designated only to be distributed at certain times, in certain amounts. Or, they could be used to fund a charity or invest in a cause. Trusts can even be set up to safeguard a pet, ensuring that they have a home and proper care until they pass away (depending on the state’s laws on pet trusts).
Trusts can be used to control better how your beneficiaries receive the assets in the retirement account. One example includes naming a special needs heir as beneficiary. Still, they can also be used to ensure that your spouse does not change the beneficiary and can withdraw funds as needed. Setting up a trust to become your retirement beneficiary is only sensible if there is a real need to control how the funds will be used in the future.
Retirement plans are not always large, and there is not always much left in an IRA when you pass away – on the other hand, maintaining trust can be costly, as it requires constant management and distribution. If your retirement account is of a certain size, then an attorney can advise you whether it would be in your interest to exercise control over how it is distributed to your heirs through a trust.
While estate plans can often grow very complex in nature, it is important to match the estate's plan – complex estates require complex yet efficient plans. Still, simpler estates may often do well with an intelligently-crafted and optimized barebones approach.
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