Naming Your Retirement Plan Beneficiary




You’ve taken the time to list your spouse and children as beneficiaries on your work sponsored retirement plan or IRA (“retirement plan”), but are they listed individually, or as beneficiaries to a trust? The answer is important, because each achieves a very different outcome. Consider the following, and then check to see whether your spouse and children, or your trust, have been designated on your beneficiary forms.

As a rule of thumb, if you have a spouse and adult children, you should list your spouse as primary beneficiary and your adult children as secondary, or “contingent” beneficiaries. This has to do with tax consequences and Inheritance IRA rules, which allow your spouse a valuable spousal rollover option, and generally allow your adult children a valuable Inheritance IRA option. When you allow an adult child to decide whether to take the Inheritance IRA option, the child has the choice of taking the money – and the tax consequences – immediately, or stretching out distributions over that adult child’s lifetime in the form of required minimum distributions (RMDs), which allows for valuable tax deferred growth.

While this is a good rule of thumb, there are a number of situations that merit listing a trust as a retirement plan beneficiary instead. When you name a trust as your retirement plan beneficiary, be aware that it can be at a tax cost, because of a required five-year pay out, or because of loss of tax-deferred growth for younger beneficiaries. Trusts also pay taxes at higher rates on those funds that can be distributed yet remain in trust. This problem can be avoided if the trustee distributes these funds to beneficiaries who may pay taxes at their lower individual rates by using a K-1 form. Despite the potential tax costs, the following are situations where the extra control that a trust can offer may be preferable.

Preserving Assets for Minor Children

You may wish to list a trust as beneficiary if your intended beneficiary is a minor, college student, or young adult because a trust can ensure that the beneficiary doesn’t have access to the funds before a specified age. Without a trust, the law provides that all of the money that you worked for during your career will be available to your child as soon as he or she turns eighteen years old, and, therefore, your career savings will be subject to the whims and mistakes of a less mature mind. At the very least, you should consider who would be in charge of the funds for that child until he or she is eighteen, because if you haven’t specified someone for that role, someone who you may not want to handle those funds may end up in that position. Most often, this scenario arises when the child of divorced parents is named as a beneficiary, and then one of the parents passes away. Unless the deceased parent had specified a trustee or guardian for those funds until the child is eighteen, courts will most often name the other parent – the ex-spouse – which is usually not the outcome that the deceased parent would choose. In all cases, because it is impossible to know what the future holds, naming your own trustee or conservator for the funds of the minor child is prudent planning. If you fail to do so, there may be nothing left for the child when he or she comes of age.

Ensuring Peace of Mind when there are Children from a First Marriage

Listing a trust as beneficiary can provide peace of mind to a spouse with children from a previous marriage. For example, in the situation for a spousal rollover above, the surviving spouse would take the rolled-over IRA of the deceased spouse, extinguishing any contingent beneficiary interests in the deceased spouse’s IRA, but would then name or re-name the children as primary beneficiaries on the new rolled-over IRA. However, there is nothing that legally obligates the surviving spouse to follow this plan or the wishes of the deceased spouse, and this can leave children from a deceased spouse’s previous marriage with nothing when the surviving spouse does not list them as beneficiaries.

In listing the trust as beneficiary in order to ensure that children from a previous marriage ultimately receive retirement assets, it is important to know that the tax cost can be especially pronounced if the current spouse and children from a previous marriage are both listed as trust beneficiaries. In this case, this means that the children, usually much younger than the spouse, must take fewer and higher RMDs, because the RMD amount is based upon the life expectancy of the older spouse.

Maintaining Control over Funds for Beneficiaries

A trust may be a better option to provide for a spouse while maintaining control of the assets if the spouse is easily influenced or is subject to creditors, because rolled-over IRA assets become the reachable property of the surviving spouse. When planning for an adult child beneficiary, considerations similar to those for a spouse beneficiary should be taken into account with respect to easily influenced children and children subject to creditors, including ex-spouses.

Preserving Assets for Beneficiaries with Debt or Marital Problems

A trust can protect beneficiaries from both intentional and unintentional withdrawals in the case of creditors, including ex-spouses, because most creditors can typically only access funds that are actually received by the beneficiary.

Clearly, there are many factors to be considered when choosing whom to list as the beneficiary of your retirement plan, and in what form. To ensure that your beneficiary designation forms are accomplishing exactly what you intend, contact Mammel Law at 248-644-6326.

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