I am frequently asked what assets should not be funded into a Trust. The first asset that I list is retirement accounts.
First, let’s distinguish between the owner of a retirement account such as an IRA or 401k and its pay on death beneficiary. For example, if you were to change the ownership of an IRA to the name of the Trustees in their capacity as Trustees of the Trust, the IRS would consider this retirement account to be “terminated” and would tax the entire contents of the IRA in the year of termination. On the other hand, you CAN and in many circumstances SHOULD make the Trust the primary or contingent pay on death beneficiary in order to assure the assets will be distributed according to your wishes set forth in the trust, such as holding them in trust for a minor, or managing them for a spendthrift. However, you need to understand the income tax consequences of doing so. This area of the law is extremely complicated primarily because of the discrepancies between the Internal Revenue Code, IRS regulations, and private letter rulings issued by the IRS. I won’t go into detail regarding those discrepancies in this blog.
Here is what you need to know. If you name a Trust as a beneficiary of a retirement plan (IRA, 401k, 403b, etc.), unless the ultimate individual beneficiary can be clearly identified, the IRS will require that the entire retirement account will have to be withdrawn within 5 years and of course subject to ordinary income tax when withdrawn. Alternatively, if the beneficiary designation contains specific language permitting the individual ultimate beneficiary to be identified, the “see through” regulation will permit the beneficiary to treat the account as an “inherited IRA” and allow the beneficiary to withdraw its content using the beneficiary’s life expectancy to calculate the minimum annual withdrawal amount, thus creating far greater flexibility and tax deferral.
A sample of language to use in designating a Trust as a beneficiary would be as follows: “Betty Jones as to 50% and Jeffrey Jones as to 50% to be further administered pursuant to the provisions of the Parent Jones Living Trust.”
If cash accounts are held outside of the Trust name, the Trustee will have no control over those assets. Thus, I highly recommend the assets be held in the name of the Trust. However, it also underscores the fact that a Trust, by itself, is not a complete estate plan. A complete estate plan should also include among other things, a durable power of attorney for property management which would permit the appointed attorney-in-fact to handle the Trustor’s legal and financial affairs that have nothing to do with the assets held in the Trust, for instance to be able to bring or defend lawsuits, handle income tax audits, etc. The Trustee of the Trust has no authority to do these things. If financial accounts are not held in the name of the Trust, the person holding the power of attorney can access those accounts, even in the event of the incapacity of the Trustor.
And sometimes there are good reasons to have accounts held outside of the Trust. Sometimes (albeit rarely) sufficient funds to pay for funeral expenses should be held outside of the Trust in joint names. For instance, if Mom passes away and all of the checking and savings accounts are held in the Trust, those accounts will remain inaccessible until the successor Trustee can present a death certificate to the bank. It may take ten to fourteen days to get the death certificates. If the family, (impoverished children) don’t have the cash or enough room on their credit cards to bury Mom, the funeral may have to be delayed until death certificates can be obtained giving access to Mom’s accounts and the funds necessary to bury her. So in that instance, it may have been advisable to have accounts held outside of the Trust in joint names to permit quick access.
There are no cookie cutter answers regarding estate planning and funding a trust and an estate planning professional should be consulted to discuss your particular situation and goals.
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