A common assumption is that a will controls how assets pass to heirs. For assets that pass through an estate, that may be true.
Retirement accounts are often an exception. A 401(k) or IRA may be among the largest assets a person owns, but these accounts generally do not pass through a will. Instead, they follow the beneficiary designation on file with the custodian, financial institution, or plan administrator where the account is held, and that information may not have been reviewed in years.
Typically, naming beneficiaries directly is the simplest and most effective approach. However, some families choose to name a trust as beneficiary when additional control and oversight are desired. This approach is sometimes referred to as a “retirement plan trust” and typically involves naming an existing trust or creating a new trust as part of the estate plan, as the beneficiary of the account.
Because retirement accounts are subject to unique tax and distribution rules, this approach is generally reserved for specific planning circumstances.
Why retirement accounts need estate planning-attention
A 401(k) or IRA transfers by beneficiary designation, independent of the will. For most account owners, naming a spouse as primary beneficiary is often the simplest path. Additional planning considerations often arise when children or other heirs are named as contingent beneficiaries.
A beneficiary’s circumstances may change in ways the original account owner may not have anticipated, including divorce, creditor claims, lawsuits, or receiving an inheritance before they are prepared to manage it. These risks are often tied to the beneficiary’s life events rather than the original account owner’s planning decisions.
Depending on an individual’s circumstances, naming a trust as the beneficiary of a retirement account may help address certain estate planning objectives.
What is a retirement plan trust?
A retirement plan trust is a trust named as the beneficiary of a retirement account, so the account’s assets are payable to the trust rather than directly to an individual beneficiary. The trustee administers those assets according to the trust’s terms.
Despite the name, a retirement plan trust is generally not a separate legal category of trust. In many cases, it simply refers to a trust that has been named as the beneficiary of an IRA, 401(k), or other retirement account.
When drafted to meet certain requirements, a trust named as a retirement account beneficiary may qualify as a “see-through” trust. Some are structured as conduit trusts, where distributions pass through to the beneficiary, while others may give the trustee more discretion regarding distributions. The appropriate structure depends on the family’s goals and should be reviewed with legal and tax counsel.
Can an existing trust be used?
An existing revocable living trust or other estate planning trust may be named as the beneficiary of a retirement account if its terms are appropriate for that purpose. However, the existence of a trust does not automatically mean it should be used as the beneficiary of retirement assets.
In some circumstances, an attorney may recommend creating a separate trust specifically for retirement accounts because retirement account distribution rules can differ significantly from the rules governing other inherited assets. For that reason, the trust document and the retirement account beneficiary designation should generally be reviewed together.
When a trust may be the appropriate beneficiary choice
A trust beneficiary may be considered when additional control, oversight, or protection is desired.
Examples may include:
- Blended families: A trust may help provide for a surviving spouse while preserving remaining assets for children from a prior marriage.
- Minor children: A trust can allow a trustee to manage inherited retirement assets until a child reaches an age selected by the account owner.
- Beneficiaries who may not be prepared to manage a large inheritance: A trust may allow distributions to be managed over time rather than providing unrestricted access immediately.
- Special needs planning: Specialized trust structures may sometimes be used as part of a broader planning strategy for beneficiaries with disabilities.
- Creditor, divorce, or lawsuit concerns: Depending on the trust design and applicable state law, a trust may provide additional structure and protections compared with an outright inheritance.
- Long-term family wealth planning: Some families prefer trustee oversight to help ensure inherited assets are managed according to specific goals or family intentions.
Potential drawbacks and costs
A trust beneficiary is not automatically the best solution and may introduce additional complexity.
- Legal fees: If an appropriate trust does not already exist, an attorney may need to create one. Even an existing trust may need to be reviewed or amended before being used as a retirement account beneficiary.
- Ongoing trust administration: Depending on the trust structure, there may be trustee fees, legal fees, tax-preparation fees, and ongoing administrative requirements.
- Additional complexity: Retirement account rules, trust rules, beneficiary designations, and tax considerations must all work together correctly.
- Potential tax consequences: Trust taxation and inherited retirement account rules can be complex and may produce less favorable tax outcomes in some situations.
- Less beneficiary flexibility: The same controls that may provide protection can also reduce a beneficiary’s flexibility and direct access to inherited assets.
- Outdated trust provisions: Many trusts were drafted before significant changes to inherited retirement account rules and may no longer operate as originally intended.
How the SECURE Act changed inherited retirement account planning
A trust named as a beneficiary of a retirement account remains subject to the retirement account distribution rules established under federal law.
Before 2020, a designated beneficiary could potentially stretch distributions from an inherited retirement account across their own life expectancy, spreading the tax impact over decades. The SECURE Act changed those rules for many beneficiaries.
Today, many, but not all, non-spouse beneficiaries must fully distribute inherited retirement account assets within 10 years of the original owner’s death. If the original owner had already reached the age at which required minimum distributions (RMDs) applied, annual distributions may also be required during years one through nine, with the remaining balance distributed by year 10.
As a result, trusts that were drafted under pre-2020 assumptions may no longer operate as originally intended. Depending on the trust structure, current rules may affect planning outcomes in several ways:
- A conduit trust may require retirement account distributions to pass through to the beneficiary within the applicable distribution period.
- A trust designed around lifetime “stretch” distributions may no longer provide the same level of long-term control.
- Distribution timing may create larger taxable income events than originally anticipated.
Because the rules depend on the account type, beneficiary type, trust structure, and timing of the original owner’s death, these decisions should be reviewed with a tax professional.
Spouses generally have the most flexibility under these rules. Certain other eligible designated beneficiaries, including a minor child of the original owner, someone who is disabled or chronically ill, or a beneficiary not more than 10 years younger than the original owner, may also have more flexible distribution options. Adult children are generally not included in that eligible designated beneficiary group.
Naming a trust as beneficiary may affect how distributions are received, managed, and ultimately distributed to beneficiaries, but it does not automatically avoid the applicable withdrawal rules.
What are possible tax implications?
In many cases, if retirement account distributions pass through the trust and are distributed to the trust beneficiaries, the tax result may be similar to what would have occurred if the beneficiaries had inherited the account directly.
However, the outcome depends on how the trust is structured and how distributions are handled. If distributions are retained within the trust rather than passed through to beneficiaries, those amounts may be subject to trust income tax rates. Trusts generally reach the highest federal income tax brackets at significantly lower income levels than individual taxpayers, which can result in higher taxes in certain situations.
For that reason, the tax implications of naming a trust as beneficiary should be reviewed with qualified tax and legal professionals before beneficiary designations are changed. A trust may provide important estate planning benefits in some situations, but those benefits should be weighed against the potential costs, complexity, and tax consequences involved.
Why professional guidance matters
Retirement plan trust decisions are highly dependent on the account type, beneficiary structure, trust language, and applicable tax rules. This article is educational only and should not be treated as legal or tax advice.
Several coordination points are especially important:
- An improperly drafted trust can create the very tax or distribution problems it was meant to avoid.
- Many trusts were drafted before significant changes to inherited retirement account rules and may need review.
- The trust document and retirement account beneficiary designation should align with one another.
- The intended benefits of control, protection, or oversight should be weighed against the costs, complexity, and tax implications involved.
Alternatives to naming a trust as beneficiary
Depending on the situation, alternatives may include:
- Naming a spouse directly as beneficiary
- Naming children directly as beneficiaries
- Updating primary and contingent beneficiary designations over time as family situations change
- Dividing retirement accounts among multiple beneficiaries
- Coordinating retirement account beneficiary designations with other estate planning documents without naming a trust as beneficiary
For many households, these approaches may be simpler and less expensive than naming a trust as the beneficiary of a retirement account.
How a trust fits into a broader estate and retirement plan
Naming a trust as the beneficiary of a retirement account is a planning tool, not a strategy on its own. It should be evaluated in the context of other beneficiary designations, estate planning documents, retirement income planning, tax planning, and broader family goals.
Decisions about withdrawal strategies, Roth conversions, beneficiary designations, and estate planning can all interact with whether and how a trust is used. In some situations, direct beneficiary designations may be entirely appropriate. In others, the additional structure provided by a trust may support broader family and estate planning objectives.
This is where coordinated financial planning matters. Retirement account decisions, trust planning, tax considerations, and estate goals should be reviewed together rather than treated as separate decisions.
How Modera can help
Modera can help clients evaluate how retirement accounts, beneficiary designations, tax considerations, and estate planning goals fit within the broader financial plan.
We do not draft trusts or provide legal advice ourselves, but we can help coordinate conversations with estate planning attorneys and tax professionals when trust planning is being considered.
Modera is a fee-only fiduciary firm with experience coordinating financial planning, tax planning, and trust-related planning considerations. We help clients assess how retirement account beneficiary decisions fit into the broader picture of wealth transfer, retirement planning, and family goals.
A trust can be a valuable planning tool in certain circumstances, but it is not the right solution for every family. The goal is to determine whether naming a trust as beneficiary is appropriate given the family’s unique situation, planning objectives, and overall financial plan.
Talk with a Modera advisor about how retirement accounts, beneficiary designations, and estate planning fit together.
