Individuals
should use extreme caution when naming a trust as beneficiary of a retirement
plan. Most revocable living trusts—whether provided by attorneys or
do-it-yourself kits—do not include adequate provisions regarding distributions
from retirement plans. When a living trust fails to include “conduit”
provisions which allow distributions to be funneled out to beneficiaries, this
may result in an acceleration of distributions from the plan at death. As a
result, the income tax payable by beneficiaries may dramatically increase. In
certain situations, a revocable living trust with properly drafted conduit
provisions can be named as the retirement plan beneficiary. At the very least,
the ultimate beneficiaries of the retirement plan would be the same as those
named in the revocable trust. Plus, the distributions can be stretched out over
the lifetime of these beneficiaries—assuming that the trust has been properly
drafted.
A
better alternative to naming a revocable living trust as the beneficiary of the
retirement plan might be to name a “standalone retirement trust” (SRT). Like a
revocable living trust with conduit provisions, a properly drafted SRT offers
the ability to stretch out distributions over the lifetime of beneficiaries. In
addition, the SRT can be drafted as an accumulation trust, which offers the
ability to retain distributions for beneficiaries in trust. This can be very
helpful in situations where trust assets must be managed by a third party
trustee due to incapacity or need. For instance, if the beneficiaries are under
the age of 18, either a trustee or custodian for the account may be required to
avoid a court appointed guardianship. Even in the case of older beneficiaries,
using a trust to retain plan benefits will offer all of the usual benefits of
trusts, including potential divorce, creditor, and asset protection.
Perhaps the best
advantage of an SRT, however, is that the power to stretch out plan benefits
over the lifetime of the beneficiary resides in the hands of the trustee than
the beneficiaries. As a result, beneficiaries are less likely to “blow it” by
requesting an immediate pay out of the plan and running off to buy a Ferrari.
Over time, the trust could provide for a beneficiary to serve as co-trustee or
sole trustee of the retirement trust. Accordingly, these trusts can provide a
useful mechanism not only to minimize tax, but also to instill responsibility
among beneficiaries.
If you have more questions, contact our Silicon Valley Estate Planning Attorneys.
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