Who Should Be the Beneficiary of Your Retirement Accounts?


See-Through Trusts for Retirement Accounts

A comprehensive estate plan should ensure that the correct beneficiaries are designated on an individual’s retirement accounts. Clients with revocable trusts have an additional factor to consider regarding whether their trust should be named as beneficiary.

Estate Planning With Retirement Accounts

Certain eligible retirement plans such as 401(k) plans and IRAs (collectively referred to herein as “Retirement Accounts”) often require special consideration in estate planning. Unlike most assets, Retirement Accounts are not titled in the name of a trustor’s revocable trust, but rather pass by beneficiary designation at the owner’s death.

People with retirement accounts typically designate an individual beneficiary that receives access to the retirement account proceeds at the account owner’s death. While naming an individual as the beneficiary of a retirement account works well in many situations, it sometimes might make sense to divert the proceeds to a trust for the benefit of the beneficiary, rather than naming the beneficiary outright.

Reasons for Naming a Trust as Beneficiary of a Retirement Account

The primary reasons for designating a trust, rather than an individual, as the beneficiary of a retirement account are to protect the beneficiary from themselves and their creditors, or to maintain the beneficiary’s access to governmental benefits. Naming a trust as the beneficiary allows the owner of the retirement account to utilize the proceeds for the benefit of the beneficiary while also protecting the beneficiary from the aforementioned concerns. Most often, these concerns arise in the context of deciding whether to name your child individually, rather than a trust, as the primary or contingent beneficiary. It is important to note that a trust must be properly structured and contain specific provisions that qualify the trust as a “see-through trust” in order to mitigate the potential loss of tax deferral benefits.

Consequences of Naming a Trust as Beneficiary of a Retirement Account

Naming a trust rather than an individual can cost you tax deferral benefits. If an account owner names his or her child individually as beneficiary, upon the death of the owner, the assets can be held in the plan until the beneficiary reaches the age of majority (which under proposed IRS regulations is age 21). At that point, the assets must be distributed to the beneficiary over the next 10 years. The same is true for a properly structured see-through trust. Conversely, if a non-see-through trust is named as beneficiary, the distribution period that begins on the death of the owner will be limited to 5 years, resulting in a loss of tax deferral benefits.

It is important to note that individuals who qualify as “Eligible Designated Beneficiaries” are not subject to the 10-year rule and can instead stretch the payments out over their remaining lifetime. Eligible Designated Beneficiaries are spouses, disabled and chronically ill individuals, minor children of the account holder (until they reach the age of majority), and other beneficiaries who are less than 10 years younger than the account holder.

Designating beneficiaries on retirement accounts is an essential part of an estate plan. Owners need to understand the consequences of naming a trust rather than an individual as beneficiary and should consult with a professional to determine which approach is best for them.

For more information on Estate Planning, contact BakerAvenue to discuss how we can help you think about your estate plan and the beneficiary designations on your retirement accounts.