Trust as Retirement Account Beneficiary: Pros and Cons

Designation of a trust as beneficiary for an IRA, 401K, or other retirement account is a popular option for retirement account holders who wish to continue to exert some control over the disposition of their assets following their death. However, account holders will need to exercise some care and attention to detail in order to make sure that the trust is properly designed to insure that their wishes are carried out in the most effective way for all concerned.

The first thing to understand is that if the beneficiary of a retirement account is not a natural person, the payout of assets from the account will become subject to a five-year limitation if the account holder dies before the required beginning date (RBD) for distributions. When this happens in the case of a non-person beneficiary, the IRS disallows use of the deceased account holder’s life expectancy for calculating the annual required minimum distribution (RMD); the assets must be disbursed over no more than a five-year period. If the account holder dies on or after the RBD, the distribution may be stretched only as far as the deceased’s life expectancy as calculated by the IRS.

There is an exception to this rule, however. If the trust is valid under state law; it is irrevocable; the beneficiaries of the trust are identifiable persons; and a copy of the trust documents are provided to the IRS by October 31 of the year immediately following the year of the account holder’s death, then the life expectancy of the oldest identifiable beneficiary of the trust may be used to calculate the RMD.

Why would someone want to designate a trust as beneficiary, instead of just designating a spouse, child, or other person? Several reasons can apply to this decision. Perhaps the most important is protection against a spendthrift beneficiary. For example, the creator of the trust may want to be sure that a grandchild does not use up all the assets before a certain age; the trust can be structured to disburse assets in accordance with this wish. Another reason might involve the grantor’s wish to provide both for a current spouse and children of a previous marriage. A trust can stipulate that the spouse may receive income from the trust and also provide an inheritance for the children.

To avoid creating unforeseen or undesired complications for beneficiaries, care should be taken in using trusts as recipients of retirement accounts. For one thing, the account holder should check with the retirement account custodian to make sure that the provisions of the trust do not conflict with the plan documents and that they pass regulatory muster. As mentioned above, care must be exercised to insure that, upon the account holder’s death, the appropriate documentation is submitted to the IRS by the October deadline; otherwise, the RMD will revert to the five-year minimum term. The trust should be structured so that it cannot disclaim the assets of the plan. When assets are disclaimed, the proceeds may become payable to a primary or contingent beneficiary, and the trust is nullified. This can be avoided by including in the trust documents what is commonly called a “disclaimer provision” that specifies disposition of the assets in accordance with certain trust provisions. Another problem can arise when certain provisions of a trust are in conflict with the retirement plan document. To avoid these and other potential pitfalls, the account holder should consult with a qualified attorney and tax professional, who can help insure that the documents are properly designed to satisfy the account holder’s requirements.

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