Retirement Accounts and Trusts
Retirement accounts and trusts…Could be like oil and water.
If you have a substantial retirement account like an IRA or 401(k), it’s not uncommon to want to name a trust as a beneficiary. There are a number of reasons.
Maybe you have underage children. Perhaps you are concerned that your heirs would spend everything the moment they receive it. Perhaps you are worried about creditors or even future divorces taking your money after you are gone. Perhaps you are just forward thinking and want to address the “what ifs” that you can’t address by simply naming a person as a beneficiary. Or maybe you just want simplicity. After all, it is much easier to know that all you need to do to change your wishes for your estate is change trust language as opposed to beneficiaries on every asset.
These are good, valid reasons to name a trust as a beneficiary of a retirement account. However, you need to know what you may not know.
If your trust was written in or prior to July 2024, and is named as the beneficiary of your IRA, it needs to be reviewed. Even if your trust was written since this date, I would recommend you still ask a few questions. Your attorney, like many others, might not be up to speed on this issue.
Why July 2024? This is when the IRS released its final RMD Regulations on both the Secure Act 2.0 of 2022 and the Secure Act of 2019.
You remember that the first Secure Act of 2019 dropped a bomb on retirement account holders. It eliminated the ability to inherit a qualified retirement account and “stretch” the payout of this account over the beneficiary’s life expectancy. If you are not a spouse or in the finite list of other “eligible designated beneficiaries,” you now have 10 years to fully distribute your inherited retirement account. *This is not to be confused with the back-and-forth notices from the IRS regarding Required Minimum Distributions… we will save that for another day.
What many don’t know is that this “10 years” is only “5 years” when you, your estate, a charity, or certain trusts act as the beneficiary. This could be a huge hiccup in your planning. Imagine being forced to liquidate your entire retirement account in 5 years. What would be the tax ramifications? And bear in mind that we are in a progressive tax system - meaning your tax rate goes up as your income goes up. If your heirs are already successful…. eek!
So back to your trust. Take note that only “certain trusts” are exposed to the 5-year rule. “See through” trusts are not. These trusts can qualify for the more favorable 10-year rule. HOWEVER, this doesn’t mean your trust is safe yet.
The treatment of a “see through” trust is only as good as it’s least qualifying beneficiary. This means if you name your favorite charity along with your children, they will once again be subject to the 5-year rule.
Your trust can dictate sub-trusts for each of these beneficiaries. This would provide a work-around, but here again it is not that simple. There are 2 rules you need to follow:
1. The IRS noted that your trust should contain language to allow the division of these sub-trusts before your passing.
2. Your trust needs to specifically state what percentage of your retirement account goes to each sub-trust. This cannot be left to the discretion of your trustee.
Complex? Yes! The bottom line is, your existing trust needs to be reviewed if it is the beneficiary of your retirement account(s). It may be time for an update or two. The good news is that we are always here to help communicate with your attorney and other professionals to help you get the job done and continue living Life on purpose!