Choosing who to list as the beneficiary on your qualified retirement account is a huge decision. While the decision is ultimately the owner’s, we have a few pieces of information to share that may influence that decision. This blog post is geared towards revealing some uncommon techniques and how they may influence the inheritance your beneficiaries receive.
The Secure Act 2019: What Changed?
First, it is important to highlight one of the most significant changes from the Secure Act in 2019. After the rule changes, qualified accounts must be fully distributed to a non-spouse beneficiary within a 10-year timeframe.
10-Year Distribution Rule: Tax Implications
This means your beneficiary only has ten years to withdraw the funds from the account. We typically recommend that the beneficiaries spread out these withdrawals over the entire 10 years because the withdrawals will be treated as taxable income. Taking all the money within one year will most likely place the beneficiary in a higher tax bracket and cause more money to be paid in taxes. Spreading the withdrawals over 10 years can spread that tax liability and potentially keep more money in the beneficiary’s pocket.
Direct Beneficiary vs. Trust: Weighing the Pros
If the beneficiary is responsible and understands these tax repercussions, there is no harm in listing them directly as the account beneficiary.
When is a Trust the Ideal Beneficiary?
However, if the owner feels the need to structure the withdrawals to prevent a large tax liability or if they want to limit direct access to the funds, a trust could be listed as the account beneficiary. This means the trust would become the account owner at death, and then the assets would be distributed based on the trust guidelines.
This could be specifically useful when the beneficiary is an irresponsible adult, a minor child, or an individual with special needs, or when the original owner wants to list the successive beneficiary on the newly inherited account. There are many reasons why an individual may prefer to assign the account to a trust rather than an individual directly. These are a few examples, but there are certainly more, and the more complex a situation is, the more likely a trust may be the beneficial route.
Potential Downsides of Naming a Trust
However, there are some downsides to listing the trust as the beneficiary. Various types of trusts are available, so it is important to ensure that you have the correct estate planning tools in place. Some trusts require that the inherited assets be distributed over a 5-year timeframe instead of the standard 10 years. Also, some trusts are able to retain income and RMD’s within the trust, but then this could also trigger a higher level of taxation since trusts are taxed at the top tax rate.
Choosing the Right Trust: Estate Planning Considerations
The taxation and distribution rules of the trust depend on if it is a See Through trust or if the trust is setup for a Conduit or Accumulation purposes. This is why it is important to meet with your estate planning attorney to determine what type of trust is the best fit for your situation. Sometimes, it may be appropriate to have more than one trust depending on the complexity of the estate.
- Under the Secure Act of 2019, retirement assets must be fully distributed to the beneficiary within a 10-year timeframe.
- Qualified withdrawals are treated as taxable income, so strategic withdrawals may allow the beneficiary to reduce the amount of taxes paid.
- A trust can help guide the beneficiary down this tax-efficient route, but they include a few potential drawbacks to be aware of.
Speak With a Trusted Advisor
If you have any questions about college savings, our investment portfolio, taxes, retirement planning, our 401(k)-recommendation service, or anything else in general, please give our office a call at (586) 226-2100. Please feel free to forward this commentary to a friend, family member, or co-worker. If you have had any changes to your income, job, family, health insurance, risk tolerance, or your overall financial situation, please give us a call so we can discuss it.
We hope you learned something today. If you have any feedback or suggestions, we would love to hear them.
Zachary A. Bachner, CFP®
with contributions by Robert L. Wink, Kenneth R. Wink, and James D. Wink.
If you found this article helpful, consider reading:
- Navigating College Funding
- Financial Planning Mistakes to Avoid
- Debt Repayment Strategies
- How to Negotiate a Raise