Retirement Accounts

Your retirement funds can be your legacy-producing secret weapon. 

For many Americans, retirement accounts comprise a substantial portion of their wealth. Yet, few people think about utilizing their retirement assets to provide for generational wealth.  Statistics bear out the sad fact that most beneficiaries see these inherited funds as a windfall and choose to withdraw all your hard-earned money within 18 months of your death, usually at the highest tax rate and blowing one of the best opportunities they have for wealth generation.  However, when properly transferred, your retirement assets can be one of the greatest opportunities for wealth building available under the tax laws.

Have you ever considered how you might grow your estate so that it can be a gift to not only your children, but also your grandchildren and beyond? Do you anticipate one or all of your children spending their inheritance without much thought? The vast majority of non-spouse heirs to retirement accounts blow a great opportunity to increase wealth by receiving outright distribution of all their inherited retirement accounts shortly after receiving them. With proper planning, your retirement accounts can be one of the greatest legacies you can leave to your heirs.

A Retirement Inheritance Trust is an effective tool to ensure your retirement assets are not squandered that also gives your heirs the gift of continued tax-free growth based upon their own life expectancy, while allowing you to design how those assets are distributed. The ability to maximize income tax deferral and accumulate wealth is one of the greatest advantages of a Retirement Inheritance Trust. Proper planning can allow your heirs to take advantage of the “stretch-out”, allowing your assets to continue to grow tax-free over time rather than being distributed outright and having to pay income taxes right away.

Another major benefit of Retirement Inheritance Trusts is that they provide protection in many scenarios. These important protections include asset protection from creditors, lawsuits and bankruptcy, and divorce protection. Further, properly drafted retirement trusts can ensure protection for minors, as well as the elderly or disabled. If a beneficiary is entitled to government benefits, the trust can be designed to keep them from being disqualified to receive aid.

A Retirement Inheritance Trust is a separate trust that would accompany your Will or Living Trust to specifically address the unique asset of your retirement accounts. Retirement accounts are subject to many particular governmental requirements and the trust must be designed to address them properly to ensure the accumulation of the wealth over time and to increase the impact of your estate’s legacy.

Retirement Accounts and Estate Planning

For many Americans, retirement accounts comprise a substantial portion of their wealth. When planning your estate, it is important to consider the ramifications of tax-deferred retirement accounts, such as 401(k) and 403(b) accounts and traditional IRAs. (Roth IRAs are not tax-deferred accounts and are therefore treated differently). One of the primary goals of any estate plan is to pass your assets to your beneficiaries in a way that enables them to pay the lowest possible tax.

Generally, receiving inherited property is not a transaction that is subject to income tax. However, that is not the case with tax-deferred retirement accounts, which represent income for which the government has not previously collected income tax. Money cannot be kept in an IRA indefinitely; it must be distributed according to federal regulations. The amount that must be distributed annually is known as the required minimum distribution (RMD). If the distributions do not equal the RMD, beneficiaries may be forced to pay a 50% excise tax on the amount that was not distributed as required.

After death, the beneficiaries typically will owe income tax on the amount withdrawn from the decedent’s retirement account. Beneficiaries must take distributions from the account based on the IRS’s life expectancy tables, and these distributions are taxed as ordinary income. If there is more than one beneficiary, the one with the shortest life expectancy is the designated beneficiary for distribution purposes. Proper estate planning techniques should afford the beneficiaries a way to defer this income tax for as long as possible by delaying withdrawals from the tax-deferred retirement account.

The most tax-favorable situation occurs when the decedent’s spouse is the named beneficiary of the account. The spouse is the only person who has the option to roll over the account into his or her own IRA. In doing so, the surviving spouse can defer withdrawals until he or she turns 70 ½; whereas any other beneficiary must start withdrawing money the year after the decedent’s death.

Generally, a revocable trust should not be the beneficiary of a tax-deferred retirement account, as this situation limits the potential for income tax deferral. A trust may be the preferred option if a life expectancy payout option or spousal rollover are unimportant or unavailable, but this should be discussed in detail with an experienced estate planning attorney. Additionally, there are situations where income tax deferral is not a consideration, such as when an IRA or 401(k) requires a lump-sum distribution upon death, when a beneficiary will liquidate the account upon the decedent’s death for an immediate need, or if the amount is so small that it will not result in a substantial amount of additional income tax.

The bottom line is that trusts typically should be avoided as beneficiaries of tax-deferred retirement accounts, unless there is a compelling non-tax-related reason that outweighs the lost income tax deferral of using a trust. This is a complex area of law involving inheritance and tax implications that should be fully considered with the aid of an experienced estate planning lawyer.