Setting Up a Retirement Trust

Couple reviewing legal documents

Previous generations often retired from work with a company pension—a fixed monthly payment in retirement for as long as they lived. These days, retirement plans such as IRAs and 401(k)s are much more common. The closer you get to retirement, the greater the percentage of your assets these accounts represent. For many people, a retirement plan is their largest asset, worth even more than their home.

You would think that people would plan carefully for an asset that may be worth hundreds of thousands of dollars, or more. The fact is that most people don’t understand how their estate plan affects their retirement savings; in many cases, it doesn’t affect them at all.

How can that be? The answer is that most retirement plans don’t pass according to an estate plan, even if your will or trust specifies how “all” of your assets are to be distributed. Retirement plans typically have a beneficiary designation. On the death of the account owner, the account passes to the beneficiary identified by the deceased owner, often when they created the account.

That can be a big problem. If you created a trust with the intention of protecting assets for your loved ones, your retirement accounts will not have those protections—unless you take measures to place those assets into a retirement trust. A retirement trust can help protect your hard-earned assets from creditors, lawsuits, and even from unwise decisions by your beneficiaries themselves.

What is a Retirement Trust—And Why Have One?

Usually, the named beneficiary of a retirement account is a spouse, adult child, or other family member. A retirement trust is a standalone trust designed to receive and administer an inherited retirement account for a beneficiary’s benefit. Why have a trust, rather than just allow the beneficiary to inherit the asset directly? There are multiple reasons.

Income Tax Issues

Certain retirement accounts funded with pre-tax dollars, like traditional IRAs, are taxed on distributions. Some beneficiaries may not fully understand the amount of tax that will be due when they take a distribution; they may spend the money and then be hit with a hefty tax bill in April.

To make matters worse, the federal SECURE Act, which took effect in 2020, changed the rules about the amount of time over which an inherited retirement account can be distributed. Distributions used to be “stretched” over the life expectancy of the beneficiary. Now distributions to non-spouse beneficiaries must be made within 10 years of the beneficiary inheriting the plan. That may lead to larger distributions during a given year—and more tax liability, especially if the distribution bumps the beneficiary into a higher tax bracket. A retirement trust can help ensure proper management of distributions and income tax liability.

Creditor Protection

Retirement trusts can also protect trust assets from the beneficiary’s creditors, including a divorcing spouse. The trustee of a retirement trust has the discretion to make distributions for the benefit of the primary beneficiary. Because distributions are at the discretion of the trustee, the beneficiary’s creditors cannot reach the trust assets unless and until a distribution is made to the beneficiary.

Similarly, trust assets are not considered marital assets subject to division in a divorce. In addition, the trustee cannot be forced to make distributions that would disqualify a disabled beneficiary from receiving needed benefits.

Spendthrift Protection

A retirement trust can also protect a beneficiary who lacks the maturity or responsibility to handle a large inheritance. The trustee cannot control what the beneficiary does with funds once they are distributed, of course, but can control the flow of funds to the beneficiary.

In short, a properly-drafted retirement trust provides the tax benefits of an IRA and the asset protection of a trust—the best of both worlds.

Types of Retirement Trusts

There are a variety of trusts, each of which can offer different advantages:

  • Conduit trust: This type of trust serves as a link between your beneficiary and IRA. The trust is named as the beneficiary of the IRA, and the person you select is designated the beneficiary of the trust. Ultimately, the conduit trust is the middleman and facilitates an easy transition of assets while safeguarding the IRA from creditor claims.

  • Beneficiary-controlled: These trusts may be a good choice for those who want to give their children the opportunity to manage their share of the trust at a certain point in the future. This can allow the beneficiary to exercise some control over when funds are withdrawn from the trust and for what purpose.

  • Accumulation-style: This is a type of see-through trust. It allows a trustee to determine whether retirement account withdrawals should be paid to the beneficiary or kept in the trust.

  • Retirement protector trusts: Retirement protector trusts are beneficial for those with larger retirement accounts of $300,000 or more who wish to safeguard their assets for their children and shield them from creditors. They may also be a good choice for individuals who want to use the trust for the benefit of a minor, a beneficiary with a disability, or someone who has difficulty managing money responsibly.

Your choice of retirement trust should be based on your unique circumstances and needs after consultation with an experienced estate planning attorney.

Contact an Experienced Michigan Estate Planning Attorney

If you are considering setting up a retirement trust, it’s essential to discuss your needs and circumstances with an attorney who can help you explore your options. The knowledgeable estate planning attorneys at Barron, Rosenberg, Mayoras & Mayoras work with clients regarding trust and estate planning matters to help ensure their retirement assets are protected and their future wishes will be carried out. Schedule a consultation today by calling (248) 213-9514 in Michigan or (941) 222-2199 in Florida to learn how we can assist you. You can also use our simple online contact form.