Hi, thank you for tuning into today’s Emerald GEM, which stands for Get Educated in Minutes. I’m Matthew Mancini, Wealth Planning Team Leader for Wilmington Trust Emerald Family Office and Advisory® and your host for today’s podcast. In today’s GEM I’m going to answer the question: What are the considerations involved with naming a trust as the beneficiary of a retirement plan?
Retirement plans come in many different forms, from employer plans, like a 401(k) or 403(b), to individual accounts like a traditional individual retirement account—IRA—or Roth IRA. They can make up a large amount of an individual’s estate. People can spend their entire working lives accumulating assets inside of a retirement plan to assist them in maintaining their desired lifestyle during their retirement years. If proper planning has been done, there is a chance that these retirement plans will have assets remaining in them at the account owner’s death. Making sure those assets pass to the intended parties in the most tax-efficient manner after death could be a priority for retirement plan owners.
As recent legislation has changed the way beneficiaries inherit retirement plans, it may be more important than ever to understand the options that exist. Prior to 2020, beneficiaries of retirement plans were able to take distributions over their life expectancy and spread out the associated income tax on those distributions over many years. However, since the enactment of the SECURE Act in 2020, many beneficiaries, with some exceptions, are only able to defer distributions from retirement plans for 10 years after the account owner’s death. This limitation can add a significant income tax burden on retirement plan beneficiaries, depending on the size and type of the retirement plan they are inheriting.
Retirement plan owners have the ability to designate who they want to receive their retirement account at their death by completing a beneficiary designation. Upon completion of a beneficiary designation, an individual’s retirement account will pass directly to a named “primary” beneficiary, typically a spouse for married individuals. The beneficiary designation is also used to name secondary (also referred to as contingent) beneficiaries, for example children, siblings, parents, or other family in the event the primary beneficiary predeceases the retirement plan owner. Retirement plan assets passing to beneficiaries pursuant to a beneficiary designation pass outside of an individual’s estate planning documents, like their will.
In addition to naming individuals as beneficiaries, a retirement plan owner may choose to name a trust as a beneficiary to receive retirement plan proceeds upon their death. Some reasons for naming a trust as the beneficiary of a retirement plan include alignment with your overall estate planning strategy and management and oversight of the retirement plan funds for the benefit of a minor child or disabled beneficiary.
When a trust is named as a beneficiary of a retirement plan there are two components that require consideration: First, the trust is required to receive distributions from the retirement plan, just like an individual beneficiary would (meaning over 10 years, unless an exception applies). Second, the terms of the trust govern how those retirement plan distributions will ultimately be paid out to the trust beneficiaries. Given the potential complexities, it can be critical to work with an estate planning attorney to create an appropriate trust for your retirement plan because the type of trust, and the beneficiaries of the trust, will help to determine the distribution options of both the retirement plan and trust itself. When speaking with your estate planning attorney about naming a trust as a beneficiary of your retirement plan, you should keep in mind the following:
First, the trust that is being designated as beneficiary of your retirement plan should contain the proper language to qualify the trust as a “see-through” trust. This type of trust basically takes the place of an individual beneficiary but still allows the trust to qualify like an individual beneficiary for purposes of inheriting a retirement plan. In general, a trust qualifies as a “see-through” trust by meeting specific requirements set forth in the IRS rules and regulations. The four requirements that must be met to qualify for “see-through” trust status are: the trust must be valid under state law, the trust must be irrevocable or become irrevocable upon the death of the retirement plan owner, the trust’s beneficiaries must all be identifiable and individuals, and a copy of the trust must be provided to the IRA custodian by October 31st of the year following the year of the retirement plan owner’s death.*
Second, assuming the trust qualifies as a “see-through” trust, the trust instrument should provide for how the retirement plan distributions are ultimately to be made to the trust’s beneficiaries. For example, based on your planning goals and objectives, should retirement plan distributions be immediately distributed outright from the trust to its beneficiaries? If so, the trust would be structured as a “conduit trust.” Conversely, is it preferable that the distributions from the retirement plan be accumulated inside of the trust for distribution at a future time? If so, the trust should be structured as an “accumulation trust.” Either way, the trust will receive the distributions from the retirement plan over the timeframe required to distribute the retirement plan, which is generally 10 years from the account owner’s death, unless an exception applies.
Administering the trust as a “conduit trust” requires that the trustee distribute to a trust beneficiary his or her share of the retirement plan proceeds immediately upon distribution from the retirement plan. Conversely, an accumulation trust directs the trustee to accumulate distributions made from the retirement plan to the trust and distribute those proceeds to the trust’s beneficiaries in accordance with the terms of the trust instrument. The trust instrument should state the amount and timing that distributions from the trust are to be made to its beneficiaries.
A third consideration is whether any non-individual beneficiaries, like a charity, will inherit all or part of the retirement plan. For those that are charitably inclined and include a charity as a beneficiary in their trust, this could impact the distribution options available from the retirement plan. In general, it is possible for a trust that has a non-individual as a beneficiary, like a charity, to be viewed under IRS rules and regulations as not having an individual designated beneficiary, which would require the retirement plan to be fully distributed to the trust by the end of the fifth year following the account owner’s death. For individuals that are charitably inclined, it may be preferable to name the charity as a beneficiary of the retirement plan on the plan’s beneficiary designation as opposed to having the retirement plan proceeds pass through the trust and then to the charity.
Given the nuances that are involved in naming a trust as a beneficiary of a retirement plan, it is best to consult with your financial and estate planning advisors to help determine which beneficiaries you want to inherit your retirement plans, in what amounts, and in what timeframe. These decisions will impact the options available to a trust beneficiary, and ultimately decide the requirements that must be followed when distributing from an inherited retirement plan.
Thanks again for joining us today. Please contact your Wilmington Trust advisor if you have any questions about the considerations involved with naming a trust as the beneficiary of a retirement plan. We would be glad to help you. See you next time!
* https://www.federalregister.gov/d/2022-02522/p-528
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