Beneficiary Designations for Retirement Accounts.

The Florence Cathedral, Italy is a beautiful testament to charitable giving, supporting the arts and immense wealth and power of the Medici family 500 years ago.  Which is precisely how long a trust can last under Arizona trust law.  During the Medici family dominance they collected and preserved artifacts from around the world, supported an impressive list of Renaissance artists including Michelangelo, Raphael, Donatello, and Leonardo da Vinci.  It is pretty remarkable to see the changes in the world over the last 500 years and hard to imagine what society will look like in the year 2500, let alone create estate plans that will still be interpreted in accordance with the drafter’s intentions at that time.  One of the more challenging aspects of creating an estate plan over generations is how to properly complete beneficiary designations for large retirement accounts such as 401ks and Individual Retirement Accounts (IRAs).

The income tax code considers these assets designated for retirement, not for legacy planning, therefore the tax code does not work well with trust planning and creates some nuances and complexities.  The biggest issue with these accounts is that they have yet to be subject to income taxes if they haven’t been converted to Roth IRAs.  Built into a $1,000,000 account is an income tax liability of three to four hundred thousand dollars.  To minimize the income tax burden, many owners only distribute required minimum distributions and some beneficiaries desire to continue the stretch out of the tax burden by taking distributions over their life expectancy.

What to do with relatively small accounts?

For the most part, small 401k or IRA retirement accounts (under $500,000) need not be burdened with complex planning or an extra layer of a trust.  The assets are protected from creditors under Arizona law if the money is retained in the account and the beneficiary can determine the amount and timing of distributions.

  • The most common beneficiary designations for small retirement accounts are to name the spouse as the primary beneficiary and then name children or others as secondary beneficiaries individually.

This common approach offers simplicity and maximum flexibility for the beneficies.  Naming the surviving spouse as the primary beneficiary allows the survivor to choose whether to begin or continue distributions or rollover the inherited account to the surviving spouse’s retirement account.  A surviving spouse’s right to rollover an inherited retirement account can be used to substantially increase the stretch out period.  While children and other beneficiaries can’t rollover the accounts, they can choose to take distributions immediately or over their life expectancy pursuant to the Single Life Expectancy Table.  For more information on the table and how to calculate minimum distributions see /

There are a few inherent problems with this approach.  First, the surviving spouse has ability to change the ultimate beneficiary, which may not be consistent with the owner’s objectives.  Second, each beneficiary controls the amount and timing of distributions, which may cause the account to be prematurely depleted.

What about large IRA and 401k retirement accounts?

With the stock market hitting new highs, some IRA and 401k retirement accounts are hitting seven and eight figures.  These accounts can be disproportionally large in relation to the size of the estate and the owner needs to address how the asset will be utilized in the plan.  At a minimum, the owner should consider accelerating distributions, making charitable gifts with the accounts and controlling the accounts through a trust.  Each of these items are discussed in turn.

Accelerating Distributions.

There are some instances where accelerating the retirement account distributions and paying the income taxes is more income tax efficient for the family unit as a whole, and not the individual. This can occur if the beneficiary’s income tax bracket is higher than the owner’s.  Or if the owner has low basis assets outside of the retirement accounts that need to be liquidated to support their lifestyle.  While accelerating distributions may adversely impact the owner’s current income tax obligations, it may reduce or eliminate income taxes for the family.

  • Distribute More Than Required Minimum Distributions During Lifetime. In situations where the owner has a choice about how and when to take retirement account distributions, the family may benefit by the owner accelerating distributions from the retirement account during their lifetime.  The owner’s family may benefit from reduced income tax burden at death.

For example, assume an owner needs cash and has $1,000,000 in an IRA and $1,000,000 in a stock portfolio, both of which have doubled in value.  Under these facts it is tempting at the individual level to sell the stocks and pay the lesser capital gains tax rate rather than increasing the distribution from the IRA and paying the higher ordinary income tax rate.  However, this analysis ignores the fact that the stock portfolio will receive a step up in basis at death, so the stock portfolio can pass to the beneficiaries income tax free.  Each situation is unique, so having your tax advisor assist can make a significant difference to your ultimate beneficiaries.

Naming Charities in Beneficiary Designations.

Retirement Accounts are excellent assets to give to charity for those owners who desire a portion of their assets to pass to charity.  The charity receives the distributions free of the income tax obligation and the owner is not responsible for the inherent income tax obligation under most circumstances.  The charitable beneficiaries can also be changed easily as the owner’s preferences change over time. The timing of these gifts can occur during lifetime or at death.

  • Distribute up to $100,000 directly to Charity during Lifetime from Retirement Accounts. During the owner’s lifetime, the owner can give up to $100,000 directly to a qualifying charity annually.  The distribution does not increase the owner’s taxable income, but the distribution counts towards their required minimum distribution for the year.
  • Name Charitable Organization on Beneficiary Designations of Retirement Accounts. For qualifying charities, neither the charity nor the estate will be required to pay the income taxes and other beneficiaries can receive other assets that potentially have received a step up in basis, resulting in no income taxes.

For example – Assume a decedent owned $1,000,000 in an IRA and $1,000,000 in a stock portfolio and that each asset had doubled in value before death.  If the decedent desires to give half her estate to her son and half to charity, the son will receive more assets if the charity is named as the IRA beneficiary and the real estate is given to the son at death.  This is because the charity will not be required to pay the built in income tax obligation when it receives the IRA.  And the real estate will receive a full step up in basis to $1,000,000, therefore it may be sold and distributed to the son income tax free.  Otherwise, if the son and the charity received half of each asset, the son will be required to pay income taxes on distributions from the IRA.

Naming trusts in Beneficiary Designations.

For large IRA and 401k retirement accounts (over $500,000) the account owner frequently desires to explore alternatives to naming the beneficiary individually.  For example, if (i) the account owner desires to control where the money goes upon the beneficiary’s death, (ii) the beneficiaries are minors, or (iii) the account is significant enough to warrant a third party to govern how the account is administered and determine the amount and timing of distributions.  In these instances, naming the trust in the beneficiary designations makes sense.

  • Name your Revocable Trust as the Beneficiary Designations for Retirement Accounts. Simply naming your trust on the beneficiary designation form will insure that the trust beneficiaries will share the account in the same manner as set forth under the trust.  Upon the owner’s death, separate accounts can be established for each beneficiary.  The biggest drawback on this method is the beneficiaries will all have to take minimum distributions based on the oldest beneficiary’s life expectancy.
  • Name a Beneficiary subject to a Trust for the Beneficiary in the Beneficiary Designations. Here, the beneficiary is named individually, but subject to the terms of a trust established for the beneficiary under the owner’s estate plan.  Under this method, the beneficiary’s life expectancy can be used, rather than the oldest beneficiary, thus solving the problem if there is a significant age difference between beneficiaries.

Regardless which method you choose to subject the retirement account to the trust, the terms of the trust should address how the retirement account assets will be used.  There are two types of trusts, an “accumulations trust” and a “conduit trust.”  We use both types of trusts depending on the circumstances and the owner’s preferences.

Whether your 401k or IRA retirement account is small or large, regularly reviewing your account custodian’s beneficiary designation form on file is important to insure your estate planning objectives are being met.  Naming a spouse and then your children or other beneficiaries individually on small retirement accounts is an easy solution to estate planning for retirement accounts.  However, as account sizes get larger, some circumstances warrant a review of how the accounts are used and alternative beneficiary designations that can simultaneously meet the owner’s desires and give the beneficiaries additional assets at death.  For additional topics on advanced estate planning tools see

Of course, we are happy to assist with the review of your beneficiary designations, estate plan and your estate planning objectives.  Just give us a call to set a time.