Qualified retirement plans (“Plans”) and IRAs are special types of investment accounts that grow income tax deferred, until the plan proceeds are withdrawn. Over time this special tax deferred treatment yields tremendous growth in the plan. Special care must be taken when funding Plans and IRAs to ensure that ownership of the Plan is not transferred to a Revocable Living Trust. The IRS may treat the transfer of the ownership of a Plan or IRA to a Revocable Living Trust as a distribution, in which event the full value of the plan will be treated as ordinary income. Therefore, the preferred method of funding Plans and IRAs is to name the trust as either the primary or contingent beneficiary of the plan.
Because of the special tax considerations of qualified retirement plans, you should consult with your estate planning attorney before funding the plan to your living trust. Regardless, please see the article entitled, “Who Should Be the Beneficiary of Your IRA,” and the Multi-generational IRA planning, both of which are available from the “Articles/Blog” main page.
Typically, a change of beneficiary on qualified retirement plans is accomplished by sending an instruction letter to the plan administrator (for Plans) or custodian (for IRAs) signed by the participant/owner. You can change the beneficiary of your plan or IRA to your trust using the form found here. You will note that the letter contains a statement indicating that the change is not a change of ownership. Typically, the administrator or custodian will send you its own forms that require signature, and may request additional information, and have additional requirements. Follow these precisely. If the form requires a witness or notary, make certain that the appropriate formalities are followed.
In some instances, spousal consent may be required in order to change beneficiaries of the Plan; any questions regarding spousal consent should be directed to the plan administrator and your estate planning attorney.
When changing beneficiary designations, you should verify the change with the plan administrator or custodian within 30 days of your request. Despite language in your funding instructions indicating that the change of beneficiary is not a change in ownership, some administrators or custodians may nevertheless change ownership inadvertently. Should ownership of a Plan or IRA be changed, the Internal Revenue Code allows a 60-day period during which the change of ownership can be reversed. Therefore, the sooner you verify the funding, the more time you will have to correct any mistakes made by the administrator or custodian.
Many institutions may request verification that the trust is actually in existence. Your estate planning attorney can assist you in identifying what additional documents are required by a given institution.
In most situations, you will want to name your spouse as the primary beneficiary and the trust as the contingent beneficiary of the retirement plan. On the death of the participant, the surviving spouse has the ability to rollover the qualified plan or IRA to an IRA for him/herself without any acceleration of income tax. When the spouse is named as the primary beneficiary, the spousal rollover is easy to do and qualifies for the unlimited martial deduction, resulting in no adverse estate tax consequences on the death of the first spouse. However, naming the spouse as the primary beneficiary may not be the best strategy for all planning situations.
There are some disadvantages to naming the spouse as the primary beneficiary of the Plan or IRA. Because the spousal rollover is convenient and easy, often a rollover will occur prior to the spouse receiving any counseling from an estate planning attorney as to what other tax-planning strategies are available. In some circumstances, the appropriate tax planning strategy is for the spouse to disclaim the retirement plan proceeds and allow the trust to receive the assets in order to ensure that a Credit Shelter Trust or Bypass Trust is funded.
Because disadvantages exist to this approach and because each client situation is different, it is important to consult your estate planning attorney before you change beneficiary designation on your qualified retirement plan. Your estate planning attorney can counsel you as to which tax and estate planning strategies are best for you and your estate.
Typically, when a trust is named as a primary beneficiary, the surviving spouse, and the surviving spouse’s advisors, will contact the estate-planning attorney prior to making any decisions in relation to the Plan or IRA. This gives the attorney the opportunity to counsel the surviving spouse on appropriate decisions in order to attain the client’s goals.
Not only does naming the trust as the primary beneficiary help ensure that the surviving spouse will obtain legal advice before electing a spousal rollover, it also allows for bloodline protection, creditor protection, catastrophic illness protection, and ensuring that participant’s beneficiaries inherit pursuant to detailed instructions contained in the trust.
In addition, if the spouse is named as the primary beneficiary of the retirement plan, the spouse may be reluctant to disclaim the asset to the trust, or he or she may be unable to disclaim because of a disability. Naming the trust as a beneficiary allows the trustee to disclaim, (which is typically the spouse and a helper) and eliminates the problem of a disabled spouse not being able to disclaim because there is always a successor trustee able to elect the disclaimer.
Although there are numerous advantages to naming a trust as the primary beneficiary of the retirement plan, there may be adverse income tax consequences unless care is taken to ensure that the trust qualifies as a “designated beneficiary.” A “designated beneficiary” is an Internal Revenue Service designation given to beneficiaries of Plans or IRAs who receive special income tax treatment. Normally, if the beneficiary of the plan does not qualify as a “designated beneficiary”, then all account proceeds must be distributed (and therefore subject to income tax) within 5 years of the participant’s death (if he or she dies before the required beginning date) or by December 31st of the year following death (if he or she dies after the required beginning date). Due to the complexities of beneficiary designations, you should consult your estate planning attorney for guidance.
If the trust is a designated beneficiary, then distributions after death can generally be made over the life expectancy of the oldest beneficiary of the trust. These rules are always subject to the express terms of the Plan or IRA. No decision should be made prior to your estate planning attorney reviewing the Plan or IRA. Charities, estates, and corporations do not qualify as designated beneficiaries. Trusts can qualify as a designated beneficiary as long as the certain requirements are met.
One approach is naming multiple beneficiaries of Plans or IRAs in order to allow flexibility during the settlement process. These long-form beneficiary designations are sometimes called “IRA Wills.” By naming multiple beneficiaries, each beneficiary can disclaim the Plan or IRA proceeds in order to distribute the proceeds to the desired beneficiary. All disclaimers must be made within 6 months of the date of death. See your estate planning attorney for assistance with multiple beneficiaries.
