Estate Planning for Retirement Benefits

In our practice, we have observed that more and more of our clients are coming to us with a substantial portion of their “wealth” having been accumulated in their retirement plans, including 401(k)s, Traditional IRAs, Roth IRAs, and SIMPLE IRAs, to name a few.

As I am sure many of you who are reading this already know, there are two types of retirement plans: qualified and non-qualified.  For those who do not understand the difference, Investopedia breaks it down for you here.

Estate planning for clients with retirement plans can be very tricky, depending on which type of retirement plan(s) they have—qualified, non-qualified, or both—and depending on what the client wishes to do with them.

The easiest and most simple way to plan for your death with retirement benefits is to name beneficiaries directly on your plans.  In a nutshell, when you die, each of your beneficiaries will have the option to either withdraw the beneficiary’s portion of your retirement plan immediately and pay all of the income tax due at that time, based on the beneficiary’s individual tax rate, or to roll the beneficiary’s portion of your retirement plan over into an Inherited IRA where the beneficiary can continue to defer any income tax which would have been due until the beneficiary takes distributions.

Some clients come to us, however, with specific ideas for how they want their retirement funds to be distributed upon their death—and for one reason or another do not want to name beneficiaries on their plans.  Some clients want to control the funds in their retirement plans for their children or grandchildren, perhaps because they don’t want to give their children or grandchildren the option to withdraw their portion all at one time.  Other clients want to use their retirement plans to establish education trusts for their grandchildren.  Still others have concerns that if they leave their retirement plan directly to a beneficiary, that beneficiary will spend all of the beneficiary’s inheritance and then have nothing left after just a short period of time.

When clients have these types of specific ideas for their retirement plans, we, as estate planners, must get creative.  If a client chooses to not name his or her beneficiaries directly on the plan, unless they have a—and yes, I’m going to say it—“expertly” drafted Will or Trust with specific provisions for dealing with their retirement plans, the client’s estate or trust could experience a significant income tax burden.  We, as estate planners, have several tools in our toolkit which we can employ to reduce and/or eliminate this income tax burden, including the use of conduit trusts and accumulation trusts.

If you’ve learned anything at all from this post, which I sure hope you have, I hope you have learned how important it is to have an estate plan in place, especially if you are one of those individuals with retirement plans.  And in the meantime, unless you have a really great reason not to, be sure to name your beneficiaries directly on your retirement plans!

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