Why Your Retirement Plan Should be in a Trust

Estate planning with my retirement account too? That’s right.  Most people don’t consider their retirement account when it comes to estate planning. However, retirement accounts can be one of the most valuable assets in a person’s estate. Therefore, you can’t afford not to include your retirement account in your estate planning.

There are two main goals when it comes to estate planning with retirement accounts:

1.  Asset Protection–Protecting your retirement account from failed relationships, bad habits, and lawsuits; and

2.  Maximize Growth in the value of your retirement account with compounding tax-free growth.

1.  Asset Protection 

First, you have to understand that the person(s) who inherit your retirement account are the person(s) named as beneficiaries on the beneficiary designation forms.  That means if your Will says one thing, and your beneficiary form says another, what’s on the beneficiary forms will happen and the Will won’t matter.

For example, let’s assume you had a Will that said everything to your spouse and then to your children in equal shares.  But your beneficiary forms on your retirement account named your parents instead because you completed the form 10 years earlier before you were married and had children.  If you died without removing your parents as the beneficiaries on the retirement account, then your parents would receive your retirement account assets instead of your wife and children even though your Will stated that’s how you wanted it to go.

However, let’s assume that you did everything right. You update your beneficiary forms on your retirement account with your spouse as the primary beneficiary, and if your spouse failed to survive you, then your children in equal shares.   But did you know if you did that instead of naming an asset protection trust as the beneficiary, any of the following could happen:

a.  Your Children Get Nothing & New Spouse Gets Everything.  Let’s assume you die and your spouse is the primary beneficiary on the retirement account.  Your spouse remarries and changes the beneficiary designation forms on the retirement account, names the new spouse as the primary beneficiary, and your children as the secondary beneficiaries.  But what if your spouse dies before the new spouse, and the new spouse takes your children off the retirement account as beneficiaries? That could happen. The new spouse can get your retirement account and your children get nothing.

b.  Your Children Get Nothing & Stepchildren Get Everything.  Same circumstances in  “a,” but the new spouse changes the beneficiary forms to your retirement account, takes off your children as the contingent beneficiaries, and instead includes children from a previous marriage and your children get nothing.

c.  Your Children Get Nothing & the Casino Gets Everything.  Let’s say one spouse has a bad habit, for example gambling.  During your lifetime, you were able to intervene and make sure your spouse didn’t squander your life savings and ruin the family.  But if you die first, and are no longer there to regulate your spouse’s gambling addiction, this is what can happen.  Your spouse is the primary beneficiary on your retirement account.  Your spouse liquidates the retirement account, and blows it at the casino, and nothing is left for your spouse or children.

d.  Your Child Gets Nothing & Everything Goes to a Lawsuit.  Let’s say your only child inherits your million dollar retirement account.  For whatever reason, your only child thought it was a good idea to liquidate the retirement account and instead invest that money in the stock market.    Later, your child makes a mistake while driving and causes an accident killing the other driver. Your child’s car insurance coverages only $100,000. The claim against your child is for two million.  A court could order your million-dollar retirement account, now invested in the stock market, to be paid to the deceased driver’s family.

e.  Your Child Gets Next to Nothing & Everything Goes to the Ex-Spouse.  Let’s say you and your spouse leave a million-dollar retirement account to your only child. At the time of your death, your child is married and has four children. Your child takes the million dollar retirement account and puts it in to a safe investment fund and includes the spouse’s name on the account. Six years later, your child gets divorced and depending on the circumstances, all or a significant portion of your million-dollar retirement, now invested in the stock market, could end up going to your child’s ex-spouse.

To prevent your retirement account from going to a new spouse, not your children but someone else’s children, the casino, a lawsuit, or your child’s ex-spouse, name an asset protection trust as the beneficiary.  An asset protection trust, if prepared properly, could prevent those bad outcomes from happening.  That’s why I think naming an asset protection trust as the beneficiary of your retirement plan instead of individual beneficiaries is an important part of an optimal estate plan.

2. Maximize Growth in Your Retirement Account

a.  The Power of Compounding Tax-free Growth in Your Retirement Account.  Retirement accounts are unique assets. Every year you’re putting money into your retirement account. If you’re lucky, your employer puts money in that account too.  You hope that through the years your retirement account grows along with the stock market and you have a nice nest egg when you’re ready to retire.  But the story doesn’t end there.  The contributions and stock market growth are not the best part of retirement accounts.  The best part of retirement accounts is the power of compounding tax-free growth.

To understand the power of compounding tax-free growth, let’s look at the difference between how retirement and bank accounts work.

Every year, you receive a statement from your bank stating what you earned in the account for that year.  You report that income on your income tax return and pay the tax.  For example, if you had $100 in your bank account, and made $10 in interest that year, assuming a 30% total tax due, you paid $3 in taxes. So whatever you earn in year two is based only on $107, not the full $110, because you paid $3 in taxes.

Now let’s take a look at how that same example would work with a retirement account.  Your retirement account has $100 and you make $10 that year because of growth in the stock market.  You don’t get taxed on retirement account funds until you take them out.  Therefore, in the second year you have the whole $110 as a basis to grow on instead of the $107 in the bank account where you had to reduce it by $3 in taxes.  May not seem like a big deal, but on a retirement account worth $500,000, the compounded tax-free growth on $500,000, if left alone, can turn into millions by the time it reaches your grandchildren.  That’s the power of compounding tax-free growth in your retirement account.

b.  Retirement Accounts—Asset of Last Resort to Maximize Growth Potential.  Now that you understand the power of tax-free compounding growth in retirement accounts, if you can help it, you want it to be an asset of last resort.  If you have other assets like bank and investment accounts, and you need to supplement your income, use those assets first and leave retirement accounts alone to grow tax free.  You also want to create a culture within the family so that your children, and ultimately your grandchildren, and everyone on down the line, understands the power of tax-free compounded growth of retirement accounts to maximize the growth potential of those assets.

c.  Who Should Get a Copy of the Trust for Your Retirement Account?  The short answer is that you can give a copy to whomever you want.  But if privacy is an issue, at a minimum, the following should have a copy:

(1)        Plan administrator for retirement account;

(2)        Your trustee(s); and

(3)        Your attorney.

Want Peace of Mind and a Complete Evaluation of Your Case? 

Call (610) 365-4986 NOW or Click HERE to Schedule a Consultation with Chester County Pennsylvania Estate Planning Attorney, Michaelangelo L. Dippolito.  Click HERE to see the attorney’s background. 

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• Optimal Estate Plan to Protect Your Life Savings and Family Relationships
• Why Your Retirement Plan Should be in a Trust
• An Estate Plan for 2^nd Marriages & Blended Families
• 44 Reasons Why You May Need to Update Your Estate Plan
• Annual Review of Your Estate Plan to Make Sure it Works
• Arming Yourself with Knowledge is the First Step to a New Beginning

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