Depending on whether or not you have minor children, there are a couple of options for transferring your retirement account to your beneficiaries after you and your spouse are gone. In most circumstances, listing your spouse as the primary beneficiary of your retirement account is the most advantageous thing to do from a tax perspective.

However, you should also have a contingent beneficiary (a back up to your spouse) on your retirement account. It is also important to point out that your retirement account cannot be owned by your revocable living trust. Retirement accounts such as 401Ks and IRAs must be owned by an “individual”. Therefore, careful consideration of “who” the contingent beneficiary should be needs to be thought out.

The first option for the contingent beneficiary is to list your children directly as the contingent beneficiary on your retirement account. But this does not work well if your children under the age of 18. If you list minor children as the contingent beneficiaries of the account, the court will need to get involved if you passed away. The court will need to appoint a financial guardian to accept the required minimum distributions from the retirement account. When a non-spouse inherits an IRA, the beneficiary must begin taking required minimum distributions by December 31st in the year following the year of death of the plan participant (where the account is being stretched out).  

A couple of more appropriate options are to list your revocable trust as the contingent beneficiary of your retirement account or to list a special type of trust called a “retirement plan trust” as the contingent beneficiary. If you list your revocable trust as the contingent beneficiary, you must make sure that you have the appropriate language in your revocable trust handle the distribution upon your passing. When you list your revocable trust as the contingent beneficiary, conduit trust provisions must be drafted into the trust. However, a major drawback from this option, is that there is no asset protection for the beneficiary. The trustee must distribute the required minimum distribution to the beneficiary or the beneficiary’s guardian-the trustee cannot accumulate it inside the continuing trust for the beneficiary.

This is why we typically recommend a “retirement plan trust” when there is a large IRA or 401(k). When our clients reach about $250,000 in aggregate retirement account value, we recommend setting up retirement plan trusts for both husband and wife. The primary advantages of setting up a retirement plan trust over listing your revocable trust as the contingent beneficiary of your retirement accounts is threefold.

The first major advantage is the stretch out of the retirement account. This generally amounts to five times or more in the value of the account being passed to the beneficiary over their lifetime as compared to the account value at the time the account is first inherited. For example, for a $500,000 retirement account, the account is stretched out over the beneficiary’s life expectancy. The amount the beneficiary will enjoy over his or her lifetime is likely to be about $2,500,000. This amount could be more or less depending on the age of the beneficiary at the time they inherit the account through the trust. The younger the beneficiary is the greater the value of the stretch out due to the time value of money in an untaxed environment.

The second major advantage of the retirement plan trust is that the trustee can accumulate the required minimum distribution inside the trust for a particular beneficiary. The reason that this is important is that the trustee can shut the funnel off to the trust and provide the beneficiary with creditor protection. This can serve to protect a beneficiary from a divorcing spouse, a creditor or a lawsuit. 

The third major advantage of the retirement plan trust is that downstream beneficiaries are easier to plan for through a trust than on a beneficiary form. If the beneficiary in the trust predeceases or doesn’t use his or her portion of the retirement plan trust, you can list that share to pass to the next generation (grandchildren). For more information on retirement plan trusts, call our office at 760-448-2220 and request my article on this special type of trust to protect your family.