Hello. My name is Kyle Krasa and I’m an estate planning attorney in Pacific Grove, California. I’m certified by the state bar of California, as a legal specialist in estate planning trust and probate law. The purpose of this video is to give you general information about an important aspect of estate planning law so that you can be prepared when working with your own attorney. Watching this video does not establish an attorney client relationship. The law is far more complex and nuanced than can be explained in a few short minutes. As a result, before acting on any of the information contained in this video, you should consult a competent attorney who is licensed to practice law in your community. With that understanding, I hope you enjoy my video and you find it informative. Thank you.
When you are living and you own a retirement plan, you never want to change the ownership of that retirement plan to your trust. So most of your assets, if you have a trust-based plan, an estate plan designed around a revocable living trust, for most of your assets, you’re actually going to retitle those assets to your trust. When it comes to a retirement plan, such as an IRA, 401(k) 403(b) plan, a 457 plan, you do not want to change ownership to the trust. You need to keep the ownership of the retirement plan in your name. However, you might want to name a trust as a beneficiary of your retirement plan. So it’s okay for your retirement plan to end up in a trust after your death. Just not while you’re still living.
Now, when you do name a trust as a beneficiary of a retirement plan, the trust has to have very specific and special provisions. It must be drafted very carefully. It can’t just be a typical living trust. There has to be very specific provisions built into your trust to navigate very complex rules that are involved. Anytime we mix a retirement plan with a trust. However, um, sometimes naming a trust as a beneficiary of retirement plan can be very beneficial. So what are some of the reasons for naming a trust as a beneficiary of a retirement plan?
Well, number one, you might have a minor beneficiary, maybe a minor child, someone who’s five years old and clearly if they inherit from you, when they’re five years old, they’re not going to be able to manage their inheritance. So having a trust that names a responsible adult third party as a trustee, at least until the minor child reaches an age of maturity makes a lot of sense.
A second reason why you might want to name a trust as a beneficiary of retirement plan is for asset protection. So the general rule in California as in most States is that you cannot create a trust for yourself with your own assets and give yourself asset protection. That’s known as a self settled trust, and there is no asset protection. There are other benefits of setting up the trust, but not asset protection. However, if you set up a trust for the benefit of somebody else, you can give that other party asset protection. For more information on this planning opportunity, please see my other video entitled, “The Beneficiary Controlled Trust.”
Now, a third reason to name a trust as a beneficiary of a retirement plan might be for control. You might want to give the lifetime right of your retirement plan to one beneficiary, but you might want to control where any unspent portion of that retirement plan goes after that beneficiary’s death and a trust could facilitate that kind of planning.
A fourth reason might be for better planning with contingent beneficiaries. So it is true on a beneficiary form with a retirement plan company that you can name contingent beneficiaries, but you can’t get really detailed with it. You can’t provide a lot of different hypothetical situations. Um, it’s pretty much one contingent, uh, level in that’s it. With a trust. We can be much more detailed, much more specific. We can plan for a whole host of “what ifs” that we just can’t do in the confines of a beneficiary form.
Now, what we want to keep in mind when we’re thinking about naming anybody as the beneficiary of a retirement plan, whether you’re naming an individual directly or whether you’re naming a trust, is we want to do it in a way that maximizes the planning opportunities for the beneficiary. We want to minimize tax, and we want to be able to allow the beneficiary to keep as much of the retirement plan in the protected retirement plan structure as possible. We want to maximize that. Because when you inherit a retirement plan, uh, for the most part, um, unless, unless you’re a spouse and under special circumstances, it might be a little different, but for the most part, you’re going to have to start beginning taking a required minimum distribution within a certain set of a, of a few years. And the idea is to be able to minimize that required amount, that you have to take out in order to maximize the planning opportunities for your beneficiaries.
So the first thing that we want to do when we’re trying to maximize the planning opportunities for our beneficiaries, and we’re trying to maximize the length of time that the beneficiaries are going to be able to keep the inherited, retirement plan assets in the retirement plan is we want to make sure that the trust is treated as a designated beneficiary.
So this DB here, sometimes we call it, designated beneficiary is a term of art. And as long as a trust is, is viewed as a designated beneficiary, then we can maximize the, um, the, the impact of the retirement plan structure for our beneficiaries as long as possible. Now, there are four elements to, uh, to ensure that a trust will have this coveted designated beneficiary or DB status.
The first element is a trust must be valid under state law. Now, hopefully this is a pretty easy bar, um, to, uh, to meet because if you hire any competent attorney, hopefully your trust is valid under state law. Maybe if you’re trying to do the planning yourself, you might have a problem there, but any competent attorney should ensure that your trust will be valid under state law.
The second required element to treat a trust as a designated beneficiary is that the trust must be irrevocable. Now the trust can either be irrevocable at its inception, or it can become irrevocable upon the retirement plan owner’s, death. And most trusts do become irrevocable upon the trust maker’s death. However, be aware that in a community property state like California, a lot of times two spouses will form a joint trust together. And upon the death of the first spouse, all or a portion of the trust might remain revocable. So that could be a problem. So we just need to make sure that at least by the time the retirement plan owner dies, the trust has become irrevocable, or at least by the time that the asset is going to be designated into the trust, the trust has become irrevocable. A third element is that there must be, um, identifiable, designated beneficiaries as beneficiaries of the trust. So in other words, we want to look right through the trust and we want to see, can we identify who the beneficiaries are and are they, um, designated beneficiaries?
And what we mean by that is basically to be a designated beneficiary, it must be a person, a living, breathing person. So what they cannot be, they cannot be a charity or, um, your probate estate. Now, I don’t think too many trusts are going to name your probate estate as the beneficiary, but you might name a charity and you might have a few individual beneficiaries and a few charitable beneficiaries. And the existence of that charity can present a problem because a charity does not have a life expectancy. A charity is not a human being. And so therefore there are no, uh, it just confuses the rules. Now this issue can be drafted around, but we just have to be mindful of the fact that the presence of a charitable beneficiary can cause a problem for the trust being qualified as a designated beneficiary.
Finally, the fourth element is really for your successor trustees to know about. And that is that the trust documents must be given to the plan custodian by October 31st of the year after you pass away. So your successor trustee has this affirmative duty to present certain trust documents to the plan custodian, to the retirement plan company, the holder of the retirement plan within a certain period of time. So that the retirement plan holder has basic information about the trust. So if we meet all of these elements, then the trust can be designated or considered a designated beneficiary. And that will maximize the amount of time that a beneficiary is able to, to, um, stretch out their inherited retirement plan. If the trust is not a designated beneficiary, then there’s a much shorter period of time that the beneficiary will be able to use and enjoy the benefits of the inherited retirement plan. If the retirement plan owner died before reaching, uh, age 72, then, um, the, the beneficiary only has five years to be able to enjoy the retirement and the inherited retirement plan before all the assets have to be taken out of the inherited retirement plan and taxed.
If the deceased retirement plan home owner was over 72, when he or she passed away, then the beneficiary would have to use the deceased owner’s remaining life expectancy. And depending upon how old that person is compared to how old the beneficiary is, could be, make a big difference. So we want to have that designated beneficiary status. Now, if you saw my other video entitled, “Inheriting a Retirement Plan,” you’ll know that there are really two types of, uh, beneficiaries. Um, we have, uh, the first type here, let me make a, make some room here on my virtual whiteboard. The first type is what’s known as an eligible designated beneficiary, and that kind of beneficiary can use his or her life expectancy. Um, so if it’s a young beneficiary, uh, they can stretch it out over a long period of time. Um, a non eligible designated beneficiary must withdraw everything within 10 years of the retirement plan owner’s death.
Now that 10 years is better than the five years that might apply if you don’t have a designated beneficiary at all. So just by ensuring that the trust is a designated beneficiary, we’ve already doubled the amount of time that the beneficiaries have to enjoy the structure of the inherited retirement plan. Now, when, who is an eligible, designated beneficiary, again, I get into more detail with that in my other video, entitled, “Inheriting a Retirement Plan,” but it’s five categories of individuals, the surviving spouse of the retirement plan owner, a minor child until that minor child reaches age of majority, and must actually be a child of the retirement plan owner, a disabled beneficiary, a chronically ill beneficiary, or a beneficiary who is not more than 10 years younger than the deceased plan owner. So those beneficiaries have life expectancy. And if we name a trust as a beneficiary and we have multiple, uh, beneficiaries.
So for example, let’s say that we have a trust and the trust names, three children as beneficiaries, one child is five, the other child is 10, the other child is 15. If we have a trust and we name the trust 100% as the beneficiary, their retirement plan and there are three children who are beneficiaries of the trust. The rule here, when we name a trust as beneficiary is we have to use the oldest trust beneficiary’s life expectancy. So we’re going to have to use this child’s life expectancy. These other children are going have to use their oldest sibling’s life expectancy. That’s if we name the main trust, there, there are ways around this. Maybe instead of naming that trust directly, you name each child’s separate share 1/3 each and then each child would be the oldest beneficiary of their own trust.
So that’s a way to get around it, but just keep in mind that when we have an eligible, designated beneficiary, who can base required minimum distributions of an inherited retirement plan on their life expectancy. Um, and we have a trust. We need to use the oldest trust beneficiary’s life expectancy. All right, let’s get into the mechanics and the meat of a specifically designed retirement trust. It’s very important that a trust that’s designed to be a beneficiary of retirement plans is drafted in a very specific manner. And we basically have two choices as to how we can design the trust. Um, one trust, uh, one choice is known as a conduit trust, and then the other structure, the other choice is known as an accumulation trust.
So whenever you have a retirement plan, trust or retirement trust, trust is designed to be the beneficiary of retirement plan. When we’re drafting that we need to think, do we make it a conduit trust, or how do we make it an accumulation trust? So let’s talk about the conduit trust first and how that works. So let’s assume that we have a trust. So this a rectangle here is the trust and the trust was named as a beneficiary of a retirement plan. Let’s say it was a beneficiary of an IRA. So we have an IRA which is represented by this triangle and there’s money in the IRA. Okay. What a conduit trust says, the beneficiary here is outside of the trust. There are certain, as we mentioned, there are certain required minimum distributions. If you’re an eligible, designated beneficiary, it’s based on your life expectancy. If you’re not, it’s based on the ten year rules, as long as the trust is a designated beneficiary.
So you have certain required minimum distributions, a minimum amount that must be withdrawn from the retirement plan. What a conduit trust says is, Hey trustee, anytime you are required by law to take a minimum distribution out of the retirement plan, you have to immediately turn around and give that required minimum distribution directly to the beneficiary. It has to come outside of the trust. So the trust acts as a conduit for the required minimum distributions. They come out of the retirement plan and they also come out of the trust, right to the beneficiary. Now, the problem is that anything that comes out to the beneficiary, we’re going to lose a lot of the benefits we have by naming a trust as a beneficiary, we’re going to lose the control issue because we’re handing the required minimum distribution directly to the beneficiary. We’re going to lose the asset protection, because if it comes outside of the trust here, the asset protection is gone.
We’re going to lose control. Because again, if it comes outside of the trust, the beneficiary can do whatever they want with that required minimum distribution. Now, why would we draft trusts this way? Well, the reason is because by naming it as a conduit trust, it helps us navigate specific tax rules. Remember how I said that? If you can use your life expectancy, um, to determine how rapidly you must take out the requirement of distributions, we have to use the oldest trust beneficiary’s life expectancy. Well, if we make it a conduit trust, we only have to look at the current beneficiaries to determine the oldest beneficiary. We don’t have to look at contingent beneficiaries. So for example, if I have a trust and I named my 10 year old son as a lifetime beneficiary of my trust and upon his death, everything then goes to my 41 year old cousin.
Uh, then it’s perfectly fine because all we have to do, we don’t have to factor in my cousin’s age. We only look at my son’s life expectancy to determine it because it’s a conduit trust. Um, now the problem with a conduit trust though, uh, today is under, um, previous rules prior to the passage of the secure act, which took place. It took a fact that January 1st, 2020, prior to the secure act, almost everybody could base life expectancies on there or the base requirement of distributions on their life expectancies. And so, as a result, the requirement minimum distribution was a relatively small amount relative to the overall size of the retirement plan. So it didn’t really hurt that a certain amount came out to the beneficiary because it was a relatively small amount. And it made the taxation made this issue of not having to worry about contingent beneficiaries for determining the oldest trust, beneficiary a lot easier.
So that was very common and it was not really a big deal best that the RMDs were going to be relatively small. Now, unless you’re an eligible designated beneficiary, where you have, um, you have the ability to stretch the retirement plan out over your life expectancy. You’re going to have to do it within 10 years. And so the problem is the RMD is going to be a hundred percent of the retirement plan within 10 years. So then everything is going to come out and the entire retirement plan will lose its protection. So those clients who, uh, have drafted retirement plan and trusts in the past, you might have conduit provisions in them and they might not work as well because in the past, the amount that would have been exposed to the beneficiary would have been a relatively small amount spread out over that beneficiary’s life expectancy.
And now, unless they’re one of those five special categories of beneficiaries, everything is going to come out within, uh, within 10 years. Well, if we don’t like the conduit trust, what’s our alternative? So the alternative then would be what we call the accumulation trust. So, so with an accumulation trust, um, we, uh, again, we, we do have to think about, let me put that back there, cause we do have to think about the oldest trust beneficiary. If the beneficiary is entitled to use their life expectancy over it, but the difference here is yes, there will still be required, minimum distributions. Um, however, um, those required minimum distributions do not have to, by the terms of the trust, be then distributed to the beneficiary. The accumulation trust allows the trustee to allow the required minimum distributions to accumulate inside the trust. So they still have to be taken out of the retirement plan, but they can be left in the trust.
So that way they’re still under the control and the management of the trustee. And there’s still a level of asset and divorce protection for the beneficiary. It’s up to the trustee to decide under the terms of the trust, whether or not, and how much to distribute to the beneficiary. So, and it’s better asset protection and better control when it’s an accumulation trust. Now, why wouldn’t we do an accumulation trust all the time? Well, that’s the issue here is that if it’s an accumulation trust and the beneficiary is entitled to use his or her life expectancy to stretch out the required minimum distributions from the retirement plan, then we have to look not only at the current beneficiaries, but we also have to look at the contingent beneficiaries to determine, um, life expectancy, to determine who the oldest trust beneficiary is. And so in a situation where I named my son as a lifetime, a beneficiary of my trust for his whole life, and then upon his death, it goes to my 41 year old cousin.
Now we’ve got to use my cousin’s life expectancy. We’ve got to factor that in. We can’t just use my son’s life expectancy. So instead of having maybe 90 years to be able to stretch out the retirement plan, we only have 60 years. And so that’s a big difference. Um, also if we have a charity as remainder beneficiary, that can be a problem, right? So I leave everything in my son in trust for his lifetime and upon his death, everything goes to my favorite charity. The charity has a life expectancy of zero. And so we, we were not able to stretch anything out over my son’s life expectancy. It hurts the primary beneficiary. We have to look at the contingent beneficiaries to decide how this applies. So when we have, um, an eligible, designated beneficiary gets their user life expectancy, this rule of, of having a factor in contingent beneficiaries to determine whether we have designated beneficiaries – human beings as beneficiaries, and to determine who the oldest one is creates a big problem.
The way to draft around that is to put in a, what I call cutoff provisions. And that is where we say that under no circumstances, can anyone be a beneficiary of that trust if they are older than the primary beneficiary. So that cuts it off. So we know who the oldest life expectancy is. Um, we would also exclude any charities as contingent beneficiaries as well with those cutoff provisions. Now, the problem there is that, um, that might frustrate the trust maker’s intent, they might say, well, that’s, that’s what I want. I want this kind of plan there, but that’s the issue. We do have to factor in those contingent beneficiaries. And we do need to have a cutoff. If it’s not an eligible, designated beneficiary, and we’re not using life expectancy, then those cutoff rules are probably not necessary. Although it’s still a good idea to have some language that would, that would have those cutoff rules apply if and when necessary. Now a special note here is that if you do have a special needs trust, if you’re planning to name a special needs trust as the beneficiary of a retirement plan, you really need to make it an accumulation trust, and you really need to have these cutoff, uh, provisions in the trust. So any client that has a special needs trust that’s named as the beneficiary of a retirement plan, please review this with your attorney, make sure that it’s drafted as an accumulation trust and that it has those cutoff provisions.
Now, the final thing I want to mention here, we focus so much on how the trust is structured and, um, having all the right language in there and being so careful about it. We could have the greatest trust in the world. We can have all the perfect planning and we can mess it up in a real easy way.
And that is if we don’t fill out the beneficiary form properly. Now, it seems very simple. What, how was it so hard? I’m going to download the beneficiary form or my financial advisor is going to give me a copy of the beneficiary form. And I’m just going to name the trust as the beneficiary. Not necessarily. There are very specific ways to name the trust as the beneficiary of a retirement plan. If your trust has multiple sub trusts with multiple beneficiaries, a lot of times you want to name those sub trusts as the beneficiaries and not the original trust as a beneficiary. So you have to be very careful.
So if you’re naming a trust as a beneficiary of a retirement plan under no circumstances, should you fill out the beneficiary form yourself and you know what? Don’t let your financial advisor fill it out for you. Don’t let your accountant do it, make sure your attorney fills it out because there are very specific ways. We don’t want to mess up the entire plan because we didn’t fill out the beneficiary form correctly.
I hope this gave you a good overview of the mechanics of naming a trust as a beneficiary of retirement plan. And I hope this helped facilitate or help emphasize the point that any trust that is named as a beneficiary of a retirement plan must be very carefully drafted. So please consult a competent attorney before making any such decision with regard to naming a trust as a beneficiary of retirement plan. Thank you very much.
I hope you enjoyed watching my video. As I mentioned at the beginning, this is not intended to be a substitute for proper legal counsel. Before acting on any of the information contained in this video, you should consult a competent attorney who is licensed to practice law in your community. Thank you.