Why You Should Name a Stand-Alone Retirement Plan Trust as Beneficiary of Your IRA and Other Tax-Deferred Retirement Accounts

Naming the right beneficiary for your tax-deferred retirement accounts is critically important. Most people want to continue the tax-deferred growth of their accounts for as long as possible, pay the least amount in income taxes and achieve the maximum stretch-out. Required distributions after the owner dies will be based on the beneficiary’s age and life expectancy, so the younger the beneficiary (such as a child or grandchild), the longer the tax-deferred, wealth-compounding stretch-out can last.

Naming a beneficiary outright for your tax-deferred retirement accounts has several disadvantages:

(1) If the beneficiary is a minor, distributions will need to be paid to a guardian; if no guardian exists, one will have to be appointed by the court. When the child turns 18, the account is theirs to do with as they wish, which is a potentially disastrous outcome.

(2) A beneficiary may be tempted to take larger distributions from the account or—worse yet—cash out the entire account, triggering a large tax and destroying your plans for continued long-term tax-deferred growth of the account for your beneficiary. The money is then available to the beneficiary’s creditors, a divorcing spouse and in bankruptcy. (A recent U.S. Supreme Court decision in Clark v. Rameker held that an IRA inherited outright by a non-spouse beneficiary is not protected from the beneficiary’s bankruptcy creditors.)

(3) There is the risk of court interference if your beneficiary becomes incapacitated.

(4) The extra income could cause a beneficiary with special needs to lose his or her eligibility for valuable government benefits.

(5) If your beneficiary is your spouse, he/she is under no obligation to follow your wishes and will be able to name a new beneficiary for the IRA.

Naming a stand-alone retirement trust as your beneficiary provides you with more control over, and protection for, your tax-deferred accounts. Ideally, it is a separate, carefully drafted trust designed specifically for the purpose of satisfying all IRS requirements for a qualified beneficiary. Because it must meet certain stringent requirements established by the IRS, it is best if the designated beneficiary is not part of a revocable living trust or some other trust which could disqualify it as a beneficiary. For this reason, the most appropriate trust is a “Stand-Alone Retirement Plan  Trust.”

After your death, required minimum distributions (RMDs) will be paid by the plan into the trust for the benefit of your beneficiary. The trust can be required to pass these distributions directly out to your beneficiary (this is called a “Conduit Trust”) or the trust can accumulate these distributions (called an “Accumulation Trust”) to protect distributions from your beneficiary’s creditors or predators (for example, a divorcing spouse).  The trustee can then pay out trust assets over time according to the trust’s instructions (for example, for higher education expenses, a down payment on a home, medical bills, or any other identifiable need.

Because a Stand-Alone Retirement Plan Trust is the named beneficiary instead of an individual, no guardian is needed for minor children and there is no risk of court interference upon the beneficiary’s incapacity. An Accumulation Trust allows the trustee to receive the RMDs and then use its discretion to provide for a special needs beneficiary without jeopardizing the beneficiary’s eligibility for government benefits. Most important, your beneficiary is prevented from cashing out the retirement plan and suffering a huge tax hit, or taking large, imprudent distributions for the wrong reasons. Your ongoing control assures the continuing power of long-term, asset-protected, tax-deferred growth of your requirement account. If a conduit trust is used, distributions that are paid out to the trust beneficiary would become subject to creditor claims. Therefore, for maximum creditor protection an Accumulation Trust might  be preferable, depending upon your assessment of your beneficiary’s needs.

NOTE:  Another advantage of the Stand-Alone Retirement Plan Trust is that it allows you to maintain the long-term relationship you’ve enjoyed with your trusted financial advisor by appointing him or her to serve as the trustee’s investment advisor and money manager. This helps prevent your beneficiary or trustee from making the wrong choice by selecting a financial advisor who is less competent and experienced.

Typically, you will want to name successor beneficiaries in your Stand-Alone Retirement Plan Trust. This allows you to maintain effective control over who will receive the retirement plan proceeds if your initial beneficiary should die before the retirement plan account is fully paid out.

With this powerful planning technique your legacy can grow dramatically in value over time for successive beneficiaries.  To evaluate whether this planning strategy is appropriate for you and will help you achieve your goals, consult a qualified estate planning attorney who is experienced with the Stand-Alone Retirement Plan Trust.

Who should establish a Stand-Alone Retirement Plan Trust?  Anyone in any of these categories:

1. Any individual or couple with combined qualified retirement plans of at least $200,000 or more.  At that level, it makes economic sense to use the Retirement Plan Trust.  Amount alone is not the only issue, and sometimes it makes sense for someone with a smaller retirement plan to use a Retirement Plan (see below).

2. Concerned that beneficiaries would not make good choices regarding distribution.  Would you be willing to give all of your beneficiaries a large sum of money today with no instructions or oversight?  If the answer is no, then what happens after your death to turn those beneficiaries into instantly good money managers when they may be emotionally overwhelmed by your death?

3. Concerned that a beneficiary could lose part of the inherited IRA in a divorce, bankruptcy, or lawsuit.

4. A person with a minor child who would inherit the IRA.  One year’s guardianship alone will more than offset the cost of using a Retirement Plan Trust.

5. If a beneficiary could become incapacitated.  One year’s guardianship alone will more than offset the cost of using a Retirement Plan Trust.

6. If a beneficiary qualifies for a governmental assistance program and inheriting the IRA will cause them to lose those governmental benefits.  This includes things like school loans, scholarships, grants, etc.

7. In a marriage where there are children from a prior relationship and you don’t want your surviving spouse to disinherit your prior children from the IRA after your spouse dies.  You can name the trust with the spouse being a lifetime beneficiary, then have it go to your kids.  You might also include life insurance in the plan so that both are covered.