Retirement Accounts – And How to Plan for Them

 In Blog, Retirement

For most Americans, retirement accounts are one of their biggest assets. When it comes to leaving our retirement accounts to our loved ones through an inheritance, special planning strategies apply. Those accounts are treated differently than our other assets, such as our home, checking and savings accounts.

Knowing About Your Accounts

Typically, retirement assets such as IRAs or 401Ks are passed to individuals we have stated in the beneficiary designation form. For example, it is common for a married couple with children to designate the spouse as the primary beneficiary and children as secondary. In some situations, however, it is advantageous to name a trust—rather than a particular individual—as the designated beneficiary.

Once the retirement account becomes inherited by a non-spouse beneficiary (i.e. children), it is important to understand that IRS regulations treat this inherited retirement account differently. Specifically, once inherited, the beneficiary, no matter their age, is obligated to begin taking required minimum distributions (RMD) from such funds within a short time. The beneficiary will sometimes have the option to take the distributions over the course of five years or over the beneficiary’s life expectancy (known as the “stretch”). Remember, the beneficiary will be obligated to pay the income taxes on any distributions they receive. The goal in planning for inheriting retirement assets is to maximize the stretch so that the tax-sheltered, long-term growth benefits of retirement accounts are maximized.

IRAs and other retirement accounts were designed precisely for a specific purpose: retirement. They were not intended as a savings mechanism for future generations. Tax laws are designed based on this assumption, and appropriate planning is crucial. Trusts can serve as an appropriate conduit to protect and preserve these assets.

Not all trusts are created equal, however, and each type will carry benefits and costs when working in the context of retirement accounts. Sometimes people will name their living trust as the beneficiary. This may have drawbacks, including a more fixed distribution schedule and the lack of creditor protection. Even worse, the IRS may not consider the revocable living trust as a qualified beneficiary, resulting in the assets becoming immediately taxable income. Many people are unaware of these and other tax implications that revocable living trusts have on retirement assets.

Standalone Retirement Trusts

This is when the standalone retirement trust (SRT) comes into play. The SRT is a specific type of trust that, upon the death of the retirement account holder, is designed to allow retirement assets to grow tax-deferred by ensuring that the trust qualifies as a designated beneficiary. It also functions to protect the inheritance from future creditors of the beneficiary. Furthermore, naming a trust as a beneficiary may be preferable in situations where the intended beneficiary is a minor, is otherwise not able to make financial decisions, or where a specific structure of asset allocation is desired—such as with multiple children or blended families.

The SRT accomplishes the following goals:

  1. “Maximizing the stretch” and allowing for the tax sheltering that an IRA and other retirement plans provide. The primary growth engine for these retirement accounts is that they can accumulate tax-free over an extended period of time.
  2. Provide creditor protection. In light of the recent Supreme Court case Clark v Rameker (2014), inherited assets are not shielded from creditor claims in bankruptcy proceedings. Rather, they may be treated as income and assets of the beneficiary, and thus, may be claimed by creditors (an example would be if the beneficiary gets a divorce or if he or she is involved in a lawsuit). SRTs provide a wall of separation between trust assets and a beneficiary’s creditors.
  3. We want to provide a structure for how retirement funds may be used. For instance, if you wish to state that your beneficiaries can only use the funds for education or health purposes, the trust would allow you to specify under what circumstances the funds can be used. Additionally, for young beneficiaries or financially irresponsible beneficiaries, the SRT would allow you to name a Trustee who will manage the funds until the beneficiary reaches a mature age.

Be Confident With Your Planning

The Standalone Retirement Trusts are a part of your estate plan along with your will and living trust, power of attorney, etc. SRTs are not a substitute for a living trust, but rather they allow for comprehensive protection of retirement assets. If you want to learn more about how SRTs operate, please schedule a consultation by calling us at (714) 372-2215 or emailing us directly at cbasar@caglabasarlaw.com and we will be happy to go over your questions in more detail.

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