Most people have some type of retirement account—whether a 401(k), IRA or pension—so proper estate planning for these assets is essential. When planning for retirement accounts, there are three key considerations to ensure your account is distributed in a manner that is consistent with your overall estate planning goals.
Naming a Beneficiary
When it comes to planning for retirement accounts, most people choose to name their spouse as the primary beneficiary and then designate children or other individuals as contingent beneficiaries. While this approach will typically avoid the Probate court, it will not offer any preservation or protection for the inherited accounts.
A smarter approach is to place your retirement account in a trust, which can provide ongoing benefits to your spouse, children or other named beneficiaries.
Benefits of a Trust
In most cases, leaving your retirement account to your beneficiaries via a trust provides an increased level of protection and flexibility.
A trust that is specifically designed to receive retirement account balances allows the account to continue growing, on a tax-deferred basis, for as long as possible. It also protects the inherited balance from the beneficiary’s creditors and allows for distribution in accordance with the deceased account holder’s wishes.
Retirement accounts are treated as “income in respect of a decedent,” and as a result, any amounts withdrawn from non-Roth accounts are subject to income tax at the beneficiary’s ordinary income tax rate.
Given the income tax treatment of inherited retirement accounts, retirement trusts must be carefully drafted. If set up incorrectly, a trust could require the entire inherited account balance to be paid out within five years of the account owner’s death. In such as case, long-term, tax-deferred growth of the funds would be lost, and beneficiaries would be faced with a substantial (and unexpected) income tax bill. Additionally, the funds would be subject to the claims of any of the beneficiaries’ bankruptcy or judgment creditors.
Get started on planning for retirement accounts with the Socius Law Firm. We will review your retirement plan’s documentation, ensure that beneficiary designation forms are written correctly and, if needed, help to properly set up a retirement trust.