Retirement Account Planning

Although most people will not approach the current estate tax exemption amounts ($11.58 million per person), there is one kind of tax planning that is relevant for many people, and therefore an important part of Life and Estate Planning. This is planning related to Retirement Accounts -- for many people Retirement Accounts, along with their home, are their most valuable asset.

Sometimes, a tax consideration with Retirement accounts is stretching out the period of time for taking distributions from the account (the distributions are taxable income as they are received), and stretching out the time that income and gains can continue to accumulate tax free in the account. These are basically income tax issues - the more income that is paid out and sooner, the more income tax there is that is paid sooner; in some cases larger distributions from a retirement account can push the recipient into a higher tax bracket; and the longer funds remain in an retirement account, the longer they can potentially appreciate tax free.

In many situations, the tax issue of trying to stretch out the time funds can remain in a retirement account is not a relevant issue - because the funds are wanted to live on or support a person's lifestyle, and the issue is more one of financial planning - how much to take out when, to provide support and also make the funds available for as long as possible.

There are rules, however, regarding required minimum annual distributions from a retirement account. Once you reach the age of 72 you are required to start taking distributions from your retirement account - many people have seen the abbreviation RMD, for Required Minimum Distributions, if you're dealing with your own account or perhaps helping your parents.

The idea behind RMDs is that the federal government established a tax advantaged way for people to save for retirement, to encourage this saving, but the goal was to provides funds to support someone once they retired to be spent during retirement; not as an additional estate planning tool to assist families in accumulating wealth to be passed on to future generations, rather than being spent during retirement. Hence, distributions are required, and there is a formula for determining the amount.

Similarly, if a retirement account is passed on to someone else after the account owner dies, the federal government (IRS) has rules regarding how quickly the funds from the account must be paid out to the beneficiary, and thus subject to being taxed as income when received.

There was a law called the SECURE Act passed in December 2019 that shortened the "stretch" period for some beneficiaries and changed the rules in general. A surviving spouse who receives his or her spouse's retirement account can take required minimum distributions over his or her life-time based on their life expectancy; same for a beneficiary who is "disabled" or "chronically ill" as defined in the IRS statutes; and for a child who was a minor at the time of the decedent's death, up until the age of 28 or 36 depending on some factors, for example if the child was still in school past the age of 18.

If you're married, often the best option will be to name your spouse as the beneficiary of your retirement plan, with a trust as a "contingent"beneficiary; and if you're single, the trust as beneficiary. This is most applicable if you have minor children. If your children are adults, you may end up deciding to name them as beneficiary rather than a trust.

The idea of naming a trust as beneficiary is related, for example, to wanting to protect the retirement account funds passed to a child for the longest period of time possible.

There are two types of trusts you can use when you name a trust as the beneficiary of a retirement account - a "conduit" trust or an "accumulation" trust. With a conduit trust, all distributions from the retirement account to the trust are paid out to the beneficiary as received (when a trust is named as the beneficiary of a retirement account, the plan/retirement account pays out distributions to the trust). With a conduit trust, the funds are basically treated as being received by the beneficiary, and the "stretch" period of the beneficiary applies - e.g. to 28 or 36 for a child who was a minor at the time the original account owner died.

There is currently some disagreement regarding the following issue, but a consensus or at least conservative consensus is that for an accumulation trust, assuming the trust meets certain requirements, the full balance from the retirement account must be received by the trust within 10 years. So, for example, if an accumulation trust has a child as a beneficiary who was 10 years old when the plan owner died, all funds from the account must be paid to the trust by the time the child is 20 years old, versus conceivably up to 36 years old.

The accumulation trust can accumulate rather than immediately pay out funds to the beneficiary, and only provide funds to the beneficiary, for example an 18 or 20 year-old adult child, for certain types of expenses, e.g. support, or for school/tuition, etc. A trust can also protect the funds from the claims of the creditors of the adult child, from a future divorce, or other circumstances. There is more about this type of asset protection provided by a trust in the Life and Estate Planning here on the website.

Although the SECURE Act rules sets out the latest date by which all funds from the retirement account must be paid out, a beneficiary is permitted to withdraw the funds more quickly. When funds are taken out of the retirement account by the beneficiary, there is income tax on the money received, but there is not an additional penalty. Some parents are concerned that an adult child would choose to withdraw all of the funds from the retirement account immediately and pay the taxes then, versus taking the distributions more slowly over time.

If there are substantial assets in the retirement account, some parents would prefer, as for assets placed in trust in general, to protect the assets for the life of their child or children, or to make them available to the adult children for specific purposes. These are scenarios we can discuss more when we meet, including a third option called a Stand-Alone Retirement Trust, which allows us to set up the trust as a conduit trust initially, and then provide a mechanism for a second look at the time of death of the retirement account holder, to possibly change the trust to an accumulation trust.

Call me at (954) 636-7498 or use the contact form and the website, and we can discuss Retirement Account Planning for you and your family.