How to Protect Your Retirement Accounts

Most people are shocked to learn that their retirement accounts can be seized once they pass to their loved ones. During your lifetime, your retirement funds have fairly comprehensive asset protection, meaning they cannot be taken in a lawsuit. Unfortunately, as soon as retirement accounts are inherited, the protection evaporates in most states. This means your hard-earned money can legally be snatched by your beneficiaries’ creditors and the courts.

As estate planning attorneys, we constantly look for ways to protect our clients and their loved ones, as well as their money and property. That is why we suggest having a conversation about your retirement accounts so that together we can determine whether a retirement trust would make sense for you.

What Is a Standalone Retirement Trust and Why Might It Be Good for You?

A standalone retirement trust(SRT) is a special type of trust designed to be the beneficiary of your qualified retirement accounts such as IRAs, 401(k)s, etc. During your lifetime, your ownership of and access to the accounts do not change. Upon your death, as long as you have properly named the SRT as the beneficiary on the appropriate beneficiary designation form, the trust will become the beneficiary, and the trustee of the trust will be in charge of withdrawing and managing the money received from the inherited retirement account according to the terms laid out in the trust document.  

The SRT is a popular planning tool because it 

  • protects inherited retirement accounts from beneficiaries’ creditors as well as predators and lawsuits;
  • ensures retirement accounts go to whom you designate—and nobody else; 
  • allows for experienced management and oversight of funds by a professional trustee;
  • protects beneficiaries from reckless spending;
  • enables proper planning for a special needs beneficiary;
  • permits you to name minor beneficiaries as immediate beneficiaries without court-supervised guardianship; and
  • facilitates generation-skipping transfer tax planning.

Divorce Creditor—A Common Example

Many parents are concerned that their in-laws may someday become the outlaws—that is, that their children may someday get divorced, and their children’s inherited money and property will be seized by a divorcing spouse.

Here is the story of Mary and Tom. Which outcome would you prefer for your children?

Option 1: Mary and Tom love their son-in-law, Mike, and think his marriage to their daughter Liz will last. They gave Liz her share of their retirement plans outright at their deaths. Five years later, Liz and Mike divorced and Mike was able to take 50 percent of Liz’s inherited retirement funds.  

Option 2: Mary and Tom love their son-in-law, Mike, but recognize that 50 percent of all marriages end in divorce. It is an unfortunate reality, so when they did their estate planning, they provided for their children but made sure the inheritances could not be taken from them. Instead of outright distributions, they passed their retirement plans in trust. Five years later, Liz and Mike divorced, and Mike was not able to take any of Liz’s inheritance. Liz was able to use the funds in the trust to create a new beginning.

Must You Have an SRT?

Not everyone needs an SRT. Depending upon your situation perhaps having asset and divorce protection provisions in your revocable living trust (RLT) will be sufficient.  However, some clients may want their retirement assets handled and managed differently for their children than they do non-retirement plan assets. As discussed below, the recent SECURE Act may mean it’s time to review your RLT to determine if changes should be made or if perhaps now would be a good time to add an SRT to your plan.

Already Have an SRT? Or an RLT? Now Is the Time to Review It

Depending on the size of your retirement account or your specific family dynamics, you may have already addressed these concerns and had an SRT prepared to handle your retirement accounts at your death. Even if you did not, your RLT may have been designed to also handle retirement account assets. However, in light of the SECURE Act, which was passed in December 2019 and became effective January 1, 2020, it would be wise to review the distribution instructions that were included in the SRT and/or any RLT.  Most trusts, whether an SRT or RLT, are typically designed using either “conduit” or “accumulation” provisions. Under the old law, if the trust had conduit provisions, the trustee would typically withdraw the required minimum distribution (RMD) from the inherited retirement account on behalf of the trust beneficiary and would then be required to immediately give that money to the trust beneficiary. The benefit of this type of provision was that it guaranteed that the ultimate beneficiary was only receiving the bare minimum amount and would stretch the withdrawals from the inherited retirement account over the beneficiary’s lifetime. 

However, because the SECURE Act did away with the lifetime stretch for most beneficiaries (with some exceptions), the conduit provisions may cause some unintended consequences. Now, most beneficiaries are required to withdraw the entire balance of the inherited retirement account by the end of the tenth year following the plan participant’s death. Therefore, a trust with conduit provisions requires the trustee to give the entire account balance to the trust beneficiary within ten years of the account owner’s death, unless the beneficiary is an eligible designated beneficiary. While this means that your ultimate beneficiary cannot cash out the inherited retirement account immediately, the entire balance will be given to your beneficiary in about ten years after your death.  And remember, once the funds pass out of the trust to the beneficiary, there is no longer any asset or divorce protection. If ten years is too soon for your beneficiary, it may be wise to consider changing your trust to include accumulation provisions instead. With accumulation provisions, the trustee can take any required distributions from the inherited retirement account and continue to hold them in a protected trust account for your beneficiary, making distributions according to the instructions you provide in the trust.

In order to make an educated decision about what is right for you there are other issues that you will want to know, including the income tax rules that may apply to a “conduit” structure vs. an “accumulation” structure. 

Want to know more about protecting your retirement accounts? Contact us today to schedule a conversation. While every situation is different, we can help you determine what plan is right for you. We are available for in-person and virtual appointments, whichever works best for you.