The Law Offices of Jeffrey G. Marsocci, PLLC logo - Estate planning attorney is Raleigh and Asheville, NC
The Plain English Attorney

It’s extremely easy for me as the attorney to recommend how assets should be retitled or beneficiaries changed on accounts so they work with a revocable trust to avoid probate. All real estate, bank accounts, brokerage accounts, mutual funds, and even life insurance should be retitled in the name of the trust. Beneficiaries on life insurance policies should also be changed to name the revocable living trust as the beneficiary. But retirement accounts are not that easy because there are income tax consequences. Unless there is a specific reason otherwise, spouses will name each other as the primary beneficiary. The contingent beneficiary is where we have to make decisions. And it is shocking how many times this is wrong.

If the revocable living trust is named as the contingent beneficiary, then all of the income taxes have to be paid out immediately upon death, or at the most over a five-year period. From there, all of the funds are no longer tax-deferred. Most of my clients with larger retirement accounts don’t like that result because of the taxes. However, the benefit of naming the trust as the beneficiary is that what’s left after paying the income taxes is held up according to the age limits you have chosen in your revocable living trust. For some of my younger clients with younger children, this may be acceptable because there is not so much in their retirement accounts yet to warrant worrying about.

We can also name children directly as beneficiaries of retirement accounts, and this has a big tax advantage because now that money can be placed into special Inherited IRA accounts that will grow tax-deferred just like your retirement accounts do now, but there are required minimum distributions that have to come out each year and income taxes have to be paid on those distributions. It’s like your own retirement accounts when you turn 70 1/2 and have to take out distributions based on your life expectancy, but the kids don’t get to wait until 70 1/2. They have to start taking out those distributions right away. The big downside is that they can whatever they want with the account at age 18 regardless of what it says in the trust. Until 18, it is usually the guardian that has financial control over the inherited IRA. They could take all of the money out at age 18 anyway and spend it.

This leads to an inevitable cost-benefit calculation based on what is important to you. Is it more important to preserve the assets until the ages you have chosen even if it means paying the income taxes and losing the ability to let the money continue to grow tax deferred? Or is it more important to give each child the ability to let the money grow tax-deferred with the understanding that they could take all of the money and run?

There is a way to get the best of both worlds by setting up an IRA Trust, naming the IRA Trust as the beneficiary, putting age restrictions in the IRA Trust (usually age 65 regardless of what is in the revocable living trust), and then a trustee will force them to leave the money in the trust unless there is an actual emergency. When they reach 65 or whatever age you choose, they will have a huge supplement for their own retirement. So these are the three options:

1) name the revocable trust to get the age restrictions knowing the taxes will have to be paid quickly,

2) naming the children as beneficiaries so they will have the option of stretching out those retirement accounts, get tax-deferred growth, but with the risk they could take everything, or

3) get the age restrictions and tax-deferred growth with an IRA Trust.

It is up to you.

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