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Retirement assets take a lifetime to build and, for many of our clients, it represents one of their most considerable assets. Many won’t spend all their retirement assets, hoping they will create an enduring legacy for their children and grandchildren. However, they are also concerned about how their retirement assets will be distributed after they die, how their beneficiaries will use them, and how much in taxes their heirs will have to pay. For them, a retirement trust may be the right solution.

What is a Retirement Trust, and How Does it Work?

Consider the following scenario: Will has worked hard to build his $1.8 million Individual Retirement Account (IRA). While he plans on using his IRA to fund his retirement, he understands that he could die before he spends down his account. With his intent to have his three children split the IRA, he could name them as beneficiaries on the account. Will’s concern is that his oldest son is in a rocky marriage, his younger son has credit problems and is known to spend money frivolously, and his young daughter is just 14 years old. He shutters at the thought of handing each a lump sum of money.  

As a solution, Will could consider a retirement trust, also referred to as an individual or standalone retirement trust. A retirement trust can be created and assigned as the beneficiary of Will’s IRA. Will would act as the grantor, and he would name someone as the trustee. He would then name his three children as beneficiaries to the trust and establish the terms of the trust for distributing the funds. 

When Will dies, the trust is funded with his remaining IRA funds, and the children’s share is held in the trust to be distributed according to its terms. 

So, how does Will’s retirement trust arrangement address his concerns? 

For his oldest son, the trust may protect his inheritance from an ex-spouse. For his younger son, it can protect his inheritance from creditors or bankruptcy. And for his young daughter, the trust will hold on to her inheritance until she is an adult. If any of his children are ever in need of government assistance, they are protected from income limits for government benefits. For all three, Will can dictate the amount and timing of distributions. By spreading their distributions over time, his children will not suffer a significant tax burden. Will can also add a disability provision so his accounts are maintained in the event of an illness or long-term incapacitation. Problem solved. 

Comparing Retirement Trust Alternatives

The retirement trust has several advantages over its alternatives—one is to simply name beneficiaries on your IRA, and another being an inherited IRA. 

When setting up IRAs, most people forgo any planning and just designated beneficiaries on their account. It’s simple and, when you die, the funds in your account automatically pass to your beneficiaries. Your heirs then have the option to stretch their required minimum distributions (RMD) over their lifetime or simply cash out and pay taxes currently. While you might prefer the first option because it can maximize your beneficiaries’ inheritance, they might choose the second option, which would put a severe dent in the inheritance and its chances of making it to the next generation. 

Another alternative used by many is an inherited IRA. But its advantages were diminished under the SECURE Act of 2019. Before the new law, beneficiaries of an inherited IRA could elect to stretch distributions over their lifetime, thereby minimizing their annual tax burden. Now, inherited IRAs are required to be fully liquidated within ten years.

While the trustee of a retirement trust is required to withdraw the minimum amount of annual distributions as required for inherited IRAs, it has the advantage of being able to stretch distributions over a beneficiary’s lifetime. This will not only minimize the annual tax liabilities, but the funds remaining inside the account can continue to grow tax-deferred, increasing the likelihood that assets will be available for future generations.

Who Can Benefit from an Individual Retirement Trust?

Because retirement trusts offer a unique structure, they can be somewhat complicated to set up. It works best for those who have amassed significant retirement assets and have specific concerns about their future distribution. Specific concerns might include

Maximizing growth:  A retirement trust enables the account to maximize the tax-deferred growth of assets through an extended payout period, increasing the likelihood of an enduring legacy. 

Minimizing tax liability: With the ability to stretch payments over a beneficiary’s lifetime, the annual tax burden is minimized.

Protecting assets from creditors: With an IRA or inherited IRA, once the assets are passed to beneficiaries, they lose their protection against creditors. Funds inside a retirement trust are protected from creditors. 

Spendthrift heirs: If you’re concerned with how the funds will be used, you can include limitations on their distribution. For example, you can have any amount that exceeds the required minimum distribution (RMD) set aside to be subject to the trustee’s discretion. 

Control of distributions for blended families: With a retirement trust, you can select a variety of beneficiaries with varying percentages. Additionally, beneficiary designations are irrevocable, giving you extensive control over the distribution of assets long after you’re passing. 

How to Know if a Retirement Trust is Right for You

If you have considerable retirement assets and share some of the concerns outlined above, you may be a good candidate for a retirement trust. The bottom line is a retirement trust can help you enjoy the tax benefits of an IRA while establishing a comprehensive asset management plan for your heirs. The trust enables you to build and customize your legacy with long-term control over distribution options. With a single document, you can combine your IRA with a trust to streamline your legacy’s administration and simplify the process.

But it may not be that straightforward. To determine if a retirement trust is right for you, you would need to meet with your financial advisor, who can help you assess your circumstances, needs, and priorities in considering your options. 

If you think you may be in a situation that could benefit from retirement trust, we invite you to meet with a Dechtman Wealth Management advisor for a no-obligation consultation. 

Important Disclosure Information

Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Dechtman Wealth Management, LLC [“DWM”]), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from DWM. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. DWM is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the DWM’s current written disclosure Brochure discussing our advisory services and fees is available for review upon request or at www.dechtmanwealth.com.

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