As an advisor, I have a guilty pleasure of attending “financial events” where I already know most of the content that is presented. Inevitably, there are one or two interesting facts that I did not know (which makes it worth going to). Here is one I heard last month: “Married couples should name their revocable trust as backup beneficiaries for their retirement accounts”. Especially for retirement accounts, advisors are trained not to add a trust as a beneficiary since, in most cases, it makes more sense to bypass any trust and estate. While I could argue that is still generally true, there are some cases where adding a trust could be preferred. Here is what I mean:
I Have a Trust, Now What?
Creating a “revocable” or “living” trust, for the right situation, can be a significant upgrade to an estate plan. Having the ability to control your assets is one of the primary objectives of estate planning in general, and sometimes a will or beneficiary designation may not be enough for a specific situation. Very few people would prefer the courts to decide where their assets should go after they pass. Even with a properly drafted will, the estate can still be subject to probate. So, having proper estate planning documents is essential.
Setting up a revocable trust allows you to pick and choose which assets can avoid probate (and court interpretation). Some people value the privacy that a trust creates by not revealing to probate (which is public knowledge) their estate amounts. This can also be advantageous for more complex situations, such as people with multiple businesses, rental properties, and accounts across different states. It could be easier to throw everything into a trust and manage the distribution from the trust language.
Which leads to the most important part. After the trust is created, any good attorney will make it abundantly clear that the trust must be funded. That means re-titling certain assets out of your name and into the name of the trust. Homes, businesses, cars, bank accounts, etc., all likely could be recommended to move into the trust. However, accounts like a 401k, IRA, Roth IRA, and others are perfect examples of accounts that you do not want to re-title. Instead, you are told to update the beneficiaries on the account. Here is where the problem could emerge, where one professional may tell you to list the new trust as a beneficiary while another professional may advise you against it.
Evaluating a Trust as a Beneficiary
The general purpose of a revocable trust is to remove assets from the probate process and provide direction for those assets after death. Retirement accounts like an IRA are already exempt from the probate process, so why is a trust necessary when the beneficiary form achieves the same result? Additionally, there have been many new changes in the last decade, most notably with the SECURE Act, around Inherited IRAs. Without proper planning, there could be major tax consequences simply by transferring a retirement account into a trust after death.
However, trusts are one of the most flexible financial planning tools available. If the top priority is to control the assets after death, a trust can fill that need. Similar to the reason for placing assets into the trust in the first place, moving retirement accounts into a trust can help protect beneficiaries who may have creditors, who may have special needs, or may be minors or otherwise cannot accept the funds. Oversimplified, the pro-trust stance focuses more on the correct distribution of all assets, while the anti-trust stance focuses more on the tax consequences and complexity.
It must also be noted that one of the reasons why trusts are more controversial is due to the legal and administrative fees over time. It is normal to expect to spend a few thousand to set up a trust. If a trust is a great solution for your specific situation, then the cost is more than worth it. However, most custodians have made the process of designating a beneficiary for a retirement account extremely easy, without any legal representation or fees. Depending on the level of complexity in a specific situation, it could be harder to justify the time and money required to set up a more difficult process to get to the same outcome.
Complexity vs. Control
The goal is to merge the two schools of thought. This ultimately means the need to be clear on how assets should be distributed after death. For example, parents with a special needs child who cannot receive an inheritance (without ruining any government assistance programs) would very likely lean towards a trust beneficiary. Calculations are then required to figure out who receives the money and how long they will have access to the newfound trust.
Generally, if the goal is for “non-financial” related reasons, such as a disabled child or a child going through a divorce, a properly created trust with a competent estate planning attorney can be a great solution. After considering any tax consequences, the trust could perfectly assist a child with minimal consequences. Blended families could also fall into this bucket, where designating assets before death may be more preferable to assuming the original wishes will be fulfilled.
If the goal is to reduce complexity while still setting the affairs in order properly, there seems to be less of a reason to designate a trust as a beneficiary. A wife who designates her husband as the primary beneficiary and all the adult children as contingents may never change her beneficiaries again. Once she passes, a death certificate can almost immediately switch her account to her husband or kids (if the husband predeceases the wife). No complications from the trust are needed.
A Trust as a Beneficiary
It is very easy for these complicated rules to overwhelm people and lead many to unintended consequences. The last thing you want is to have a spouse or parent pass away and discover the trust or entire estate plan was incorrectly set up. Work with an estate planning attorney as well as your advisor and accountant to ensure that your wishes are correct and they can be executed in the most efficient and cost-effective way possible.
TC Falkner 