Does a Retirement Plan Pass Through Probate?

No, it does not. It transfers by beneficiary designation. Much like life insurance that goes to the individual named in the policy, the retirement plan goes to the individual named on the beneficiary designation in the plan document. If you don’t have a beneficiary designated or the individual that you designated is deceased, the account value can wind up in your probate estate; and if this happens, the only choice is that all the taxes are due right away, and there is significant inflexibility. But in general, it will avoid probate.

Why is Designating the IRA Beneficiary Critical to an Estate Plan?

If you do not have a beneficiary designated, it winds up payable to your estate and in your probate. There is no longer a choice of deferring the taxes for any of your beneficiary’s. The taxes will be due in that year, and your beneficiaries will potentially lose the advantage of taking the tax deferral from your lifetime and adding that tax deferral to their lifetime. There are financial calculators that can demonstrate this to be easily a seven-figure mistake on larger retirement accounts. Maintaining control over your designations and addressing them as part of your estate planning process, is very important from a financial standpoint.

Why is it Important to Name a Contingent Beneficiary?

A lot of times we will name a spouse or the kids. For example, a person opens up an account, and he’s got a wife and one kid. Child one is named the contingent beneficiary, and they go on to have child two and three, but they never go back and revisit their beneficiary designations. So Mom passes away then Dad, and the retirement account goes to one kid when there are three. This is something that you have to stay on top of, review and address on a regular basis to make sure that whatever designations you have in place reflect your goals.

Whom Should you List as a Beneficiary on Your Retirement Plan?

Ultimately, your beneficiary is the person that you would want to inherit your money. Very often it’s your spouse, and then your contingent beneficiary would be your children. Sometimes there might not be a spouse nor a child. You can have charitable beneficiaries. The nice thing regarding charitable beneficiaries is they won’t have to pay income tax on the funds they receive. You can use this to offset some estate taxes if you are fortunate enough to have that problem, but very few of us have to worry about the estate tax. As far as whom to designate as your beneficiary, it is really up to the individual, but commonly it is family.

What Types of Trusts are Useful in Protecting Retirement Plans?

There are a number of schools of thought here. In our practice, we feel a revocable living trust is not a good vehicle to handle retirement plans. Often these are not drafted with the appropriate language to comply with the IRS service regulations to be what’s called a “see-through trust”. A Retirement Plan Trust is specifically drafted to comply with the service regulations and meet all the criteria so that if this trust is designated as the beneficiary, you will be able to preserve the tax deferral for those named beneficiaries to get the stretch advantages.

A key issue is how much to you trust your beneficiary’s to make the financially sound decision of a stretch IRA and how much can you rely on them to make the required timely elections and transfers to secure the continued tax deferral? If you leave it up to them, just as a named beneficiary, they can choose to cash it out if they would like to, and often that is a very bad decision. Often when you are looking at a large amount of money, beneficiaries often make the wrong decision. With a retirement account trust, you can control the choice, requiring that the beneficiary stretch out that IRA over their lifetime. There are further advantages to the inheritance trust, and it primarily comes from a recent decision of the Supreme Court.

In a landmark, unanimous 9-0 decision handed down on June 12, 2014, the United States Supreme Court held that inherited IRAs are not “retirement funds” within the meaning of federal bankruptcy law. This means they are available to satisfy creditors’ claims. This case an adult child, who had inherited her IRA from her mom and subsequently, due to a change in the business environment had to declare  bankruptcy due to her failing business. As the primary saver our IRAs, our retirement savings, are protected from recovery in a bankruptcy. By relying on the beneficiary designation, there is no bankruptcy protection for that inherited money that the child may receive. If it comes in the structure of a retirement plan trust, not only can we influence the choice of the child to make the right financial decision, but we can draft it in language such that we can re-invoke those protective qualities in the event of a bankruptcy by using a Retirement Plan Trust.

We can also draft protective qualities in the event of a divorce where we can make sure that any inherited IRA, or any retirement funds, stay with your child and not the future ex-spouse.

For more information on Retirement Plans & Probate, an initial consultation is your next best step. Get the information and legal answers you are seeking by calling (608) 268-5751 today.

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