By Eric Schorr

For many American adults, the two most valuable assets they own are their homes and their retirement plans.  In fact, according to a recent report by the Investment Company Institute, Americans currently hold over $24 trillion (that’s trillion, with a “T”) in retirement plan assets, including traditional IRA’s, Roth IRA’s, 401k’s, 403b’s, and other plans.  Many people fail to understand that, unlike your home and other “probate assets,” the transmission of your retirement plan at your death is not governed by the provisions of your will, but instead by the beneficiary designation form on file with the plan administrator.  While people can spend weeks or months or longer agonizing over the terms of their wills and scrutinizing the most minute details, surprisingly little thought or effort goes into planning for the distribution of their retirement plans.  

Most commonly with married couples, the retirement account holder or plan participant names his or her spouse as the primary beneficiary, i.e., the person who will be entitled to those assets upon the account holder’s death.  Sometimes this is optimal because there are benefits and options available to the surviving spouse that are not available to other potential beneficiaries.  For example, if a surviving spouse is named as the primary beneficiary of an IRA or other qualified plan, the spouse is typically allowed to “roll over” plan assets into his or her own name and treat it as his or her own IRA.   No other beneficiary has this option. Every other class of beneficiary must immediately begin withdrawing funds as soon as the plan is rolled into their names. Consequently, the beneficiary must begin paying taxes on the withdrawn funds. These mandated withdrawals are called Required Minimum Distributions or “RMD’s”.

The amount of the RMD is based on two factors: 

First, the value of the retirement account, and secondly, the life expectancy of the account holder. For younger beneficiaries, the RMD may be very small, but for older beneficiaries, the required withdrawal amount can be quite large.  Realizing the tremendous benefit of tax-deferred growth (the growth of these assets is not taxed until it is withdrawn), most IRA owners try to keep IRA assets invested as long as possible. The longer the funds stay invested, the greater they will be. 

Children are often named as the contingent or remainder beneficiaries who will receive the accounts upon the death of the second parent.  Unmarried IRA owners may name their children, nieces or nephews as primary beneficiaries.  Unfortunately, when these valuable assets are left to children who are not yet fiscally responsible, they do not last very long. Beneficiaries often do not exercise the same restraint as the original account owner. More often than not, they cannot wait to cash-out the IRA and spend the assets – often frivolously. Sometimes the money is well-spent; however, more frequently it is not. Sometimes ex-spouses or creditors walk away with the plan assets. 

So, what can you do?

Retirement plan owners who want their IRAs to provide security and long-term benefits for their children or grandchildren can prevent these problems by using an IRA trust.

The trust is named as beneficiary of the IRA, and the owner’s children or grandchildren are named as the beneficiaries of the trust. After the account owner’s death, required distributions are made from the IRA to the trust. The required distributions are based on the life expectancy of the oldest beneficiary of the trust. If the beneficiary is young, the distributions will be low. If the RMD’s are less than the growth of the plan assets, the IRA will continue to grow despite the distributions.

The advantage of the IRA trust is that the distributions are controlled by the trustee and not by the beneficiary. The provisions of the trust determine when distributions can be made to the beneficiary. Although in most instances, the trustee will only withdraw the required minimum distribution, he can be permitted to withdraw more if it is appropriate and in the best interest of the beneficiary.  

A common arrangement is for the trustee to distribute only the minimum distributions to the beneficiary until the beneficiary reaches a certain age. When the beneficiary attains that age, the beneficiary is allowed full control of the distributions.

An IRA trust can stop a fiscally immature beneficiary from wasting the IRA assets, but that’s not the only advantage.  The trustee or investment advisor named in trust will manage the IRA investments. That minimizes the beneficiary’s ability to squander the IRA’s value through poor investments.  Also, by utilizing Louisiana’s spendthrift provisions, the trust can protect the IRA from creditors, bankruptcy, and divorce.

IRS regulations provide conditions a trust must meet to qualify as a Designated Beneficiary. Failure to meet the conditions may cause accelerated distributions, or it may cause the trust to fail altogether. The four elements that must be met are: 

1. The trust must be legally enforceable under state law. 

2. The IRA custodian must have a copy of the trust agreement by the first required distribution date.

 3. The trust must be irrevocable or become irrevocable upon the death of the IRA owner. 

4. All possible beneficiaries who could enjoy the benefits of the IRA must be clearly identifiable from the trust document.

These elements are more complicated than they appear, and some standard trust language could completely disqualify the trust. So, before you name a trust as the beneficiary of an IRA or other qualified plan, be sure to seek the advice of a well-qualified estate planning attorney.