Your parents or grandparents may have retired with a comfortable pension, but today's retirees are much more likely to have their retirement funded through IRA's or similar tax deferred retirement accounts. For many families, these retirement accounts are their largest assets.
People are often shocked to learn that most estate plans have no effect on their retirement accounts. Even if your will or living trust is designed to protect assets for vulnerable heirs, the retirement accounts will be left out unless a special effort is made to bring them into the plan.
The result is that most people completely ignore their IRA's when they do their estate planning. And that could be a big mistake.
What's so different about retirement accounts?
Retirement accounts are different from other assets in several ways. First, for pre-tax accounts like traditional IRA's, the account balance includes unpaid tax liability. Think of it like a house with a mortgage. As much as forty percent of the account value represents unpaid taxes. Young and unsophisticated beneficiaries who inherit a retirement account often have trouble understanding this, which may lead them to withdraw and spend the funds with no plan for paying the associated taxes.
Second, retirement accounts are governed by a complicated set of rules. Things got even more complicated on January 1, 2020, when the SECURE Act changed many of the rules for inherited retirement accounts. Most non-spouse heirs are now required to distribute the entire account value within 10 years of inheriting it, and that triggers -- you said it -- taxes. Post-SECURE, heirs will need a plan to minimize the tax consequences of that 10-year period.
Finally, bringing your retirement accounts into your estate plan requires changing your beneficiary designation form. The directions in your will or living trust will likely take control over your real estate and other assets. Not so with retirement accounts. The beneficiary designation form is like a string that pulls the retirement account into your plan. Without special drafting in the form, retirement accounts are left with no protection for vulnerable heirs. Unless there is special planning for retirement accounts, this detail is almost always overlooked.
Who needs to plan for their retirement accounts?
Anyone with a retirement account balance of more than $250,000 should consider whether they need estate planning that is specially designed for their retirement accounts. Because retirement accounts are often the largest asset, the planning you do for them may be more important than your will! Here are some other factors that may indicate you need a standalone retirement trust:
- Blended families: Most people want the surviving spouse to benefit from the retirement account during his or her lifetime and then their own children to benefit (or their own children and stepchildren equally) after the second spouse dies. Without special planning, the children of the first-to-die spouse are at risk of being disinherited from retirement benefits.
- Young or Unsophisticated Heirs: Large retirement accounts and young beneficiaries are a terrible combination. Almost every financial advisor has their horror story, and that was before SECURE. Now we can expect the stories to get even worse! If you have accumulated a large retirement savings while your children or heirs are still young, a retirement trust is a key part of a responsible plan.
- Vulnerable heirs: Even adult children may have vulnerabilities that call for special planning. Grown children may still be at risk from divorcing spouses, business failures or substance abuse problems.
- Heirs with disabilities: It seems appropriate that heirs with disabilities have some of the best planning opportunities under SECURE next to spouses. Retirement benefits planning for a special needs heir can be a huge win-win: more support for the heir and fewer taxes.
What benefits does a standalone retirement trust provide?
Standalone retirement trusts provide special protection for special assets. They help to ensure that there will be responsible management of the 10-year distribution after death that is often required by SECURE. Furthermore, an accumulation-style retirement trust can extend that responsible management beyond the 10-year period and even for the lifetime of the heir. It may be counterintuitive to say that a standalone trust is simpler. Assuming there is trust planning for non-retirement assets, how can two trusts be simpler than one? But they are. Everyone involved in your plan (and especially the financial advisor who manages the retirement account) will appreciate that they do not have to wade through your entire will or living trust to sort out which provisions apply to the retirement accounts. Finally, remember those beneficiary designation forms we talked about? Our standalone retirement trust planning includes help with completing those forms. It is the final step that ensures you haven't ignored your IRA.
How can I learn more?
We love to talk about the benefits of retirement trusts! Call our Client Services Coordinator at 251-431-6014 to find out if you qualify for a free telephone consultation about retirement benefits planning.