Are you setting up a living trust and wondering whether to put your IRA, 401(k), or other retirement accounts into it? Is that the right move, or are you unsure about the risks involved?
Let me walk you through the common questions I get about putting retirement accounts into a revocable living trust, so you can make the right decision for yourself and your family.
One quick note before we start. I’m not giving you financial advice here. Whether to invest in a 401(k) or an IRA is a conversation for your financial advisor. This is general information only.
What You Need to Know About IRAs and 401(k)s
Here’s the high-level version.
An IRA is a retirement account that lets an individual save and invest for retirement with potential tax advantages. There are different types. A traditional IRA is usually funded with pre-tax contributions, so you can deduct what you contribute from your taxable income that year, and the earnings grow tax-deferred until you withdraw them in retirement, at which point they’re taxed as income. A Roth IRA is funded with after-tax contributions, so you don’t get an immediate deduction, but qualified withdrawals in retirement, including the earnings, are tax-free.
A 401(k) is similar but employer-sponsored. You contribute a portion of your salary on a pre-tax basis, and some employers match your contributions up to a certain percentage, which is a great boost to your savings. Contributions to a traditional 401(k) are tax-deferred until you withdraw in retirement, and employers usually offer a range of investment options, from more aggressive funds to more conservative ones.
Talk to a financial advisor about which of these fits your situation. When I do estate planning, these questions come up because people have been contributing to accounts and aren’t sure they’re set up correctly. A good advisor can build you a 10, 20, 30, or even 40-year plan around your goals and tell you whether you have enough for retirement, and enough to pass on to your children.
Should You Put Your IRA or 401(k) Into Your Living Trust?
This is one of the most common questions I get. People know to put their house and their bank accounts in the trust, but they’re not sure about retirement accounts.
Here’s the short version. For most situations, it’s not a good idea to name your trust as the beneficiary of your retirement accounts. Let me explain both sides.
The Potential Benefits
A seamless transfer. Naming the trust as beneficiary can move the funds to your beneficiaries smoothly, bypassing probate.
Added protection. Your trust can include provisions that shield the assets from your beneficiaries’ creditors, lawsuits, or divorce, keeping more money in the family.
More control over young or unwise beneficiaries. Normally, once your beneficiaries turn 18 and you pass away, they control the account and could cash it out and spend it all. If you don’t trust an 18-year-old with that money, you can use a standalone retirement trust or route the account through your trust so your trustee decides when and how the funds are distributed, holding them until the beneficiary is more mature, say 25 or 30.
The Drawbacks
Taxes. This is the big one. Because of the SECURE Act that Congress passed a few years ago, naming a trust as the beneficiary of a retirement account can mean significantly higher taxes for your beneficiaries, and the time they’re allowed to keep the funds in the account is substantially shorter, sometimes cut in half. Naming the trust also affects the timing and amount of required minimum distributions and how those distributions are taxed.
Trust restrictions. The provisions have to be written a specific way to maximize tax savings and comply with state and federal law. If they aren’t aligned with your goals, your wishes may not be honored the way you intended.
Because there’s no one-size-fits-all answer, don’t do this until you talk to an estate planning attorney and a tax professional.
The Most Important Thing: Check Your Beneficiary Designations
As a rule of thumb, make sure the people you want to receive your retirement accounts are actually named as beneficiaries. That means contacting Fidelity, Charles Schwab, or whichever institution holds your money and filling out their beneficiary forms.
I get calls all the time from children after a parent passes, saying the institution won’t release the account because there were no beneficiaries listed, or the parents only named each other and forgot the kids, and now the family has to go through probate.
Here’s how to avoid that. List a primary beneficiary, usually your spouse, and a contingent beneficiary, usually your children, in case the primary passes away or doesn’t want it. Some institutions offer a third level too. You can name multiple people at each level, such as 50 percent to your spouse and 50 percent to your kids, though in most states you’ll need your spouse’s permission to name someone other than them as primary.
This matters especially as you age. If you only name your spouse and you pass away in your 80s or 90s, your spouse has to submit your death certificate and roll the funds over. But when one spouse dies, the second often passes within six to twelve months, and in that window they frequently forget to roll the account over. Then it ends up in probate.
So pause here and make a note: check the beneficiary designations on your 401(k)s, IRAs, and pensions, and make sure each one has at least a primary and a contingent beneficiary.
Alternative Strategies for Your Retirement Savings
A few things to keep in mind beyond the trust question.
Name your beneficiaries directly. As covered above, this is the foundation.
Coordinate with your overall estate plan. Your retirement accounts and your estate plan should work together, not against each other. Talk to your estate planning attorney so the people you want to inherit actually will.
Use a trust for everything else. Even if your retirement accounts aren’t in the trust, a living trust is still essential. It protects and manages your other assets, provides for your loved ones, and heads off family conflict over who gets what. You don’t have to put everything into the trust, but you do need to weigh the tax consequences for each asset and take a holistic approach.
Ready to Set Up Your Plan the Right Way?
Take the free trust class. This roughly hour-and-a-half class breaks down the whole process of making your living trust the right way, so you don’t miss anything and can protect your house from probate with confidence. Register at freetrustclass.com. If you want more hand-holding, I also have a step-by-step course for a small fee, but many people can do it themselves after the free class.
Book a free phone consultation. If you would rather have it handled for you, talk with our team about a plan built around your family. Call us at (408) 412-1913 or visit treeoflife.legal.
Subscribe on YouTube. I post new videos every week on living trusts and how to do it yourself.
My goal is to help you keep more money in the family and give you the peace of mind you deserve.
Disclaimer: I am not your lawyer, and this article is not legal advice. It is information only. I am also not a financial advisor, and this is not financial advice. For questions about your investments or taxes, talk to a qualified advisor in your state. Reading this does not create an attorney-client relationship.
