Many Americans rely on savings in an individual retirement account (IRA), 401(k), 403(b), or 457 in retirement. Often, these accounts constitute their largest assets, sometimes surpassing the value of their home. While many have designated beneficiaries for these accounts, they often overlook how their estate planning can impact these assets, assuming it doesn’t affect them at all.
Typically, retirement plans have a beneficiary designation, and many individuals stop their planning there. However, this oversight can pose significant issues, particularly for beneficiaries inheriting an IRA. This is concerning given that retirement accounts frequently represent a substantial portion of an individual’s wealth. According to the Investment Company Institute, total U.S. retirement assets amounted to $33.6 trillion as of the fourth quarter of 2022.1
Without proper planning, beneficiaries may be harmed – more than helped – when inheriting an IRA
Compounding the issue, the federal SECURE Act, which took effect in 2020, altered the rules concerning the distribution timeline for inherited retirement accounts. Previously, distributions were “stretched” over the life expectancy of the beneficiary. However, under the new rules, distributions to non-spouse beneficiaries must occur within 10 years of inheriting the plan. The adjustment may lead to larger distributions in a single year, thereby increasing tax liability, especially if these distributions push the beneficiary into a higher tax bracket.
Passing on an IRA to a beneficiary may result in a myriad of additional challenges:
- Transferring the IRA outright to a beneficiary relinquishes the original owner’s control over who ultimately inherits the assets after the initial beneficiary’s passing, posing complications for blended or mixed families resulting from subsequent marriages.
- In cases where the IRA beneficiary is young, irresponsible, or incapacitated, they may lack the ability to effectively manage the IRA funds.
- A disabled beneficiary may forfeit state and federal government benefits upon receiving the IRA funds.
- Legal actions against a beneficiary or bankruptcy could result in the loss of the IRA funds.
- In the event of a beneficiary’s divorce, the divorcing spouse could lay claim to the retirement assets.
Retirement trusts: A smart planning solution that can help protect your beneficiaries
A retirement trust is designed to provide safeguards, including navigating complex retirement laws such as the 10-year rule, for beneficiaries concerning inherited retirement accounts. In addition to offering protection, retirement trusts can also afford greater control over the distribution of your retirement assets and how they are utilized by your beneficiaries.
The role of a retirement trustee is pivotal; they are entrusted with managing and overseeing retirement assets within the trust. As a result, the trustee determines the timing and amount of distributions to the beneficiaries. This discretion allows the trustee to protect the assets, particularly during turbulent times for the beneficiaries, such as divorce, bankruptcy, or any other creditor-related issues.
It’s important to understand that when a trust is designated as the beneficiary of an IRA, the trust’s terms must adhere to specific requirements to take advantage of the tax deferral over the 10-year rule, or longer. A standard revocable trust generally does not meet these requirements.
Even if you currently have no reservations about how your beneficiaries will manage IRA assets after your death, a retirement trust can serve as a valuable safeguard against unforeseen risks that may emerge later. For more information, contact your wealth advisor. If you’re not already a Mercer Advisors client, let’s talk.
1 Investment Company Institute. “2023 Investment Company Fact Book.” ICI Org., 2023.
The Forbes ranking of Top Women Wealth Advisor and Best-in-State Wealth Advisors, developed by SHOOK Research, is based on an algorithm of qualitative criteria, gained through telephone, virtual and in-person due diligence interviews, and quantitative data. Those advisors that are considered have a minimum of seven years’ experience, and the algorithm evaluates best practices, such as service models, investing models, compliance records as well as revenue trends, assets under management and industry experience. Portfolio performance is not a criterion due to varying client objectives and lack of audited data. Neither Forbes nor SHOOK receive a fee in exchange for rankings.
