Should retirement accounts be placed in a trust?
Putting retirement accounts into a trust can be estate-planning-friendly in many respects, but it is not always one-size-fits-all for everybody. Whether or not retirement accounts-like 401(k)s and IRAs-should go inside a trust, it's going to depends on a lot of different factors, including the goals underlying the named account holder, the tax considerations, including what the grantor is trying to achieve with the trust, and the underlying structure of the trust itself.
- Tax Consequences: One of the major concerns in placing a retirement account in a trust is the tax consequences that come with it. Most retirement accounts are specifically drafted to be taxed in a deferred manner. In other words, they are only taxed upon withdrawal. When retirement account assets are transferred to a trust, the distributions from that trust could be at a much higher tax rate. In particular, trusts pay much higher rates of taxation than do individuals on their retained income. Moreover, where the trust has not been carefully drafted, the possible loss of the ability to stretch the retirement account distributions during the lifetime of the beneficiaries accelerates the taxation.
- Beneficiary Designations: The majority of the retirement accounts have named beneficiaries, spouses or children, and those beneficiaries can inherit the account directly upon the death of the account owner. This will avoid probate, ensuring that the beneficiary will continue to take advantage of favourable tax treatment. If the retirement account is transferred to a trust, meticulous attention shall be given to the beneficiary designation in order to avoid unwanted tax consequences or limitations on distributions.
- Control and Protection: One of the advantages of putting a retirement account in trust involves the additional control one might need over the manner in which such assets are distributed upon one's death. A trust is able to state when and how beneficiaries receive the funds, which can provide protection against creditors or irresponsible spending. For young or financially inexperienced beneficiaries, this additional control can be extremely beneficial.
- Required Minimum Distributions: If a retirement account is held in a trust, then the trustee will be responsible for managing the required minimum distributions beginning in the year the account owner attains the age at which RMDs are required. Ensuring that such distributions are actually made in a manner consistent with IRS requirements can add complexity.
In that respect, although there may be some advantages to placing a retirement account in trust, consideration of tax consequences and administrative complications is important. An estate-planning professional will be able to advise whether such a strategy fits within the individual's overall goals and will assist in structuring it in a way that maximizes benefits to the beneficiaries.
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