Retirement plan assets, whether part of an employer qualified retirement plan or an IRA, comprise one of the largest sources of wealth for many individuals. Because if may be the largest asset to be passed on to heirs upon the individual’s death, and the potential tax implications that arise when distributions are made from such accounts, it is important to review and analyze one’s beneficiary designations for these accounts to determine if they are or remain the best selection.
For married individuals in a traditional family setting, the most popular and most likely the best selection is to simply name one’s spouse as the primary beneficiary. A major benefit associated with this choice is the opportunity to defer the beginning date for the withdrawal of taxable distributions after the owner’s/participant’s death to the later of (1) the year in which the IRA owner/plan participant turns age 70 ½, and (2) the year in which the beneficiary spouse turns age 70 ½. The latter deferral date would require the surviving spouse to rollover the account balance to his or her own IRA account. In the case of an IRA, this can also be accomplished by having the surviving spouse “deem” the deceased spouse’s IRA as his or her own. It is important to remember that while naming one’s spouse as the sole primary beneficiary of retirement assets provides the most flexibility and opportunity for income tax savings, the IRA owner/participant will be giving up control of naming a secondary beneficiary of those retirement assets upon the surviving spouse’s death as well as the ability to control or limit the amount of account withdrawals that can be taken from the account over a given length of time.
In the event the owner/participant is not married, of if the owner/participant has children from another marriage, the choice of an appropriate beneficiary becomes more difficult. In those situations, overall protection of the retirement assets, including control over the amount of withdrawals will most likely take priority over potential income tax savings (or, as I like to say: “Don’t let taxes be the tail that wags the dog”). In these situations, the more appropriate primary beneficiary may be a trust. That trust if often one that is part of the owner’s/participant’s existing estate plan that is also intended to hold non-retirement assets after death.
As mentioned above, benefits of naming a trust as the beneficiary of retirement assets include:
- Ability to control the ultimate beneficiaries of the retirement assets until throughout the entire account is distributed
- Ability to control the amount of withdrawals that may be taken, either in amount or by purpose, or both
- Ability to accumulate required minimum distributions in excess of immediate individual beneficiary needs
Although designating a trust as the beneficiary of retirement assets may be motivated by non-tax reasons, it is nonetheless important to properly structure the trust arrangement to provide the most beneficial tax treatment to the ultimate trust beneficiaries. The regulations governing the timing and amount of required minimum distributions that are made to trust beneficiaries can be complicated and it is best to include specific provisions addressing the administration of retirement assets in the underlying trust agreement. For that reason, it is recommended that the owner/participant utilize the services of an estate planning attorney with specialized knowledge of these regulations to draft such documents to make sure any issues in this area are properly addressed.
The vast majority of individuals simply name a trust that is created by a separate and distinct trust agreement as the beneficiary of retirement plan assets. The use of a so-called “conduit” trust as the recipient is in most cases an effective and efficient method for handling the administration of retirement plan assets. However, in the case of an IRA, it is also possible to accomplish the same objectives by establishing the same provisions within the existing IRA document itself by establishing a trusteed IRA rather than the more common custodial IRA. Such IRAs would require the use of a bank or trust company that has the necessary ability to provide trust services to the public. Without going into details that are beyond the scope of this article, the use of a trusteed IRA can provide some additional income tax benefits that may be problematic under the more familiar “conduit” trust arrangement.
A few final caveats are worth mentioning. Distributions of retirement plan assets that are held in an employer qualified retirement plan are governed by the provisions of the employer sponsored plan that may significantly limit the ability to delay or “stretch” taxable distributions even though the tax laws permit such flexibility. This could be problematic for larger accounts that name a trust as the primary beneficiary. Although I have not seen this in practice, query whether a plan participant can name an otherwise unfunded trusteed IRA as the beneficiary of the employer qualified plan retirement assets to enable a tax-free rollover to an IRA that will permit a delayed or stretched payout of taxable distribution.
Finally, if an employer plan participant is married, he or she will be required under federal law to obtain the written consent of his or her spouse to the designation of a non-spouse primary beneficiary, including a trust for the benefit of such spouse. This consent is not required for IRA beneficiary designations under federal law. However, that requirement may vary if you are a resident of a community property state. The state of Ohio does not require such consent.
Robert W. Cabanski, J.D.