Take care when you name beneficiaries

Steve Merrell |

Q: My wife and I have finally started to get our estate plan in order. We created a living trust to keep our estate out of probate and retitled our accounts to make sure they are properly included in the trust. Someone suggested that we name our trust as the beneficiary of our retirement accounts. It seems like it would help us keep everything nice and orderly. What do you think?


A: Properly naming beneficiaries on retirement accounts is one of the most important things you do in estate planning. However, using trusts as beneficiaries is tricky business. If you are seriously thinking about doing it, I suggest you get a qualified and experienced attorney to help you out. Here are some things you should be aware of.


If you are married, think carefully before naming your trust as your primary beneficiary. Spouses who are primary beneficiaries enjoy a valuable option if they inherit a deceased spouse’s IRA. On the one hand, they can choose to receive the deceased spouse’s IRA as a spousal rollover. The spousal rollover allows the surviving spouse to treat the inherited IRA as if it were his or her own—an especially powerful benefit that maximizes the IRA’s tax deferral.


On the other hand, the surviving spouse may choose to receive the IRA as an inherited IRA without the spousal rollover. This would make sense if the surviving spouse were younger than 59 ½ and needed to draw on the IRA before turning 59 ½. (Remember, you pay a 10% penalty on any withdrawals from your own IRA, or a spousal rollover IRA, before 59 ½.) An inherited IRA doesn’t have an early withdrawal penalty. The withdrawals are taxed, but there is no penalty.


For a trust to function properly as an IRA beneficiary, it must be recognized as a “qualified trust.” Qualified trusts allow the trustee to stretch out the distributions from the IRA over the expected life of the oldest beneficiary. However, if the trust is not a qualified trust, and the IRA owner dies before reaching age 70 ½, the entire IRA must be paid out by December 31 of the fifth year following the account owner’s death. If the account owner was already beyond age 70 ½, a non-qualified trust would pay out the IRA balance over what would have been the account owner’s remaining life expectancy.


For a trust to be a “qualified,” it must meet four requirements:

  1. It must be enforceable under state law.
  2. It must be irrevocable upon the death of the IRA owner.
  3. The custodian for the retirement account must receive a copy of the trust agreement by October 31 of the year immediately following the year in which the IRA owner died.
  4. The beneficiaries of the trust must be identifiable individuals.

The first three requirements are pretty easy to satisfy. The fourth requirement is tricky. For example, when the IRS is determining who the beneficiaries of a trust are, they look not only at current beneficiaries, but contingent beneficiaries as well. If any beneficiary along the chain is a non-person like a charity, church, or your alma mater, the trust is non-qualified and all the beneficiaries lose the stretch IRA benefit.


There are strategies for dealing with these pitfalls—some of them fairly simple, others more complicated. However, they all require legal expertise and intentional action. For example, you could create multiple IRAs and multiple trusts, each with specific types of beneficiaries, so that some would be qualified and others intentionally non-qualified. You could also create custom beneficiary designations that provide many of the benefits of a trust beneficiary without the potential pitfalls. The bottom line is to be thoughtful about your decision and very careful about how you put your beneficiary strategy place.



Steven C. Merrell  MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., an independent wealth management firm in Monterey.   He welcomes questions you may have concerning investments, taxes, retirement, or estate planning.  Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA  93940 or email them to smerrell@montereypw.com.