One option for naming beneficiaries for a retirement account is to set up a trust. A debate between estate planning attorneys and financial advisors has been ongoing about the advantages and disadvantages of this route.
You can build a retirement nest egg with qualified retirement savings accounts like an IRA. If the account holder passes away, what happens to the funds? In retirement accounts, investors can name both primary and contingent beneficiaries-those who will inherit the account upon the death of the original owner.
When doing this, you should consider a number of factors, including taxes and required minimum distributions. In addition, the number of beneficiaries named and whether they are the benefactor’s spouse also matters. Trusts have pros and cons that need to be considered when naming them as beneficiaries. Discover if it is the right option for you by reading on.
The benefits of a trust
It is advantageous to name a trust as a beneficiary if your beneficiaries are minors, have disabilities, or cannot be trusted with large sums of money. To avoid future estate tax issues, some attorneys also recommend establishing a special trust as an IRA beneficiary to prevent its assets from becoming part of a surviving spouse’s estate.
The disadvantages of a Trust
You should keep in mind that when a trust is named as beneficiary, the assets of the retirement plan are subject to required minimum distributions based on the oldest beneficiary’s life expectancy. When there is only one beneficiary, it does not matter as much, but if there are several heirs of varying ages, your heirs lose the ability to maximize the deferral potential.
Alternatively, naming individual beneficiaries allows each beneficiary to take a required minimum distribution based on their life expectancy, extending an IRA’s earnings.
Another wrinkle applies to trusts and accounts inherited after Jan. 1, 2020. According to the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, most non-spousal beneficiaries of an IRA must take full distributions by the end of the 10th calendar year following the IRA owner’s death. Some people are exempt from this Secure Act rule. The exemptions are for the surviving spouse and Eligible Designated Beneficiaries (EDB). For these beneficiaries, the 10-year payout rule does not apply. The trust can stretch payments out over the EDB’s lifetime, subject to the same life-expectancy rules outlined above. Eligible designated beneficiaries (EDB) can include minor children of the IRA owner (until they reach the age of majority) and disabled or chronically ill individuals who are not more than ten years younger than the IRA owner.
Factors to consider
Only the IRA owner can change the designated beneficiary of an IRA while alive. It is possible to make an exception if there is an attorney-in-fact, where a power of attorney appoints that agent to act on behalf of the IRA owner. IRA owners who cannot take care of their legal affairs can be appointed conservators by a court to take care of such matters.
When the IRA owner dies, the designated beneficiary may disclaim the inherited assets, including a trust beneficiary. The contingent beneficiary generally receives the assets at this point. If there are no other primary or contingent beneficiaries, the beneficiary will be determined according to the default provisions in the IRA plan document.