Should a Family Trust Account Be Part of Retirement Planning?

June 14, 2016 — 4:07 PM EDT

Many people think family trusts are only for the very wealthy, but if your retirement assets exceed $500,000, you may want to consider the option. Trusts are becoming more common among people retiring with 401(k)s and IRAs near or above that range. It’s not always a good idea, but there are reasons some people might want to create one. (For more, see How to Set Up a Trust Fund If You’re Not Rich.)

“The first thing I tell clients to do is not to do it,” attorney James Davis, who leads the tax practice at Gunster, a law firm headquartered in West Palm Beach, Fa., told “Trusts as beneficiaries of IRAs can be very complicated. If it is not done properly, immediate income tax consequences could result,” he says.

Done correctly, though, a trust can be useful in some situations.

Reasons to Consider a Trust

A trust may be your best option if you want to achieve the following:

  • Control If you are thinking about dividing up retirement assets among your children and grandchildren and you want to control their spending of those assets, a trust may be a good option. In the trust you can specify how and when the money will be distributed. For example, you can indicate a child does not have full access to their portion of the trust until the child is 30 years old. St. Louis University School of Law Professor Bradley E. S. Fogel writes, “It may be unwise to designate the grandchild as beneficiary even if she is an adult. For example, the grandchild may be immature, incapacitated or a spendthrift. In any of these cases, leaving the IRA to the grandchild in trust, as opposed to outright, would better protect the grandchild and the assets. The trust must be carefully structured, however, so that the grandchild’s life expectancy is used to calculate the required minimum distributions.”
  • Stretch  The IRS requires the distribution of your retirement assets, even those that have been inherited using a Roth IRA, but a properly designed trust can expand their lifespan. Davis recommends using separate trusts for multiple beneficiaries: “That way, each individual beneficiary can use his or her own age for the purposes of determining the required minimum distributions.” He goes on to say, however, that “sometimes it is easy to split the IRA into multiple IRAs if you have multiple beneficiaries” rather than use a trust. 
  • Asset Protection When a beneficiary inherits a Roth IRA, the IRS requires that the distributions be based on his or her age. These distributions can go into a child’s individual trust until he or she reaches the age designated by the trust. (For more, see How Trust Funds Can Safeguard Your Children.)

Find a Trust Specialist

If you do want to explore using a trust, the key thing to do is find someone who understands the IRS rules. Arizona financial advisor M.D. Anderson, who specializes in inherited IRA issues, warned that it is critical to hire someone who understands the IRA’s rules; otherwise, the money can be lost to taxes.

“Not surprisingly, the Treasury Regulations require that if distributions are going to be stretched over the life expectancy of trust beneficiaries, that the trust beneficiaries must be identifiable in the first place, which generally means they should either be identified by name, or identified as members of a “class” of beneficiaries that could be identifiable when the time comes (e.g., “my children” or “my grandchildren” would be fine, but “whoever my trustee decides to make distributions to” would not). Notably, embedded in this requirement that all beneficiaries be identified is that they be identifiable as designated beneficiaries, which means they must be individual, living, breathing human beings as beneficiaries,” writes Michael Kitces, a financial planner with a website he calls “Nerd’s Eye View.” 

Consider Costs

In addition to finding the right professional, also be sure you take a close look at the costs involved in setting up a trust. Just the initial setup can come to anywhere between $1,500 and $5,000, to pay both a knowledgeable attorney and an investment manager. Also, you will need to pay someone to file the trust’s tax return, which will add about $500 to $1,500, depending on the complexity of the trust. 

The Bottom Line

Making a trust the beneficiary of your retirement assets could be your best choice in some situations. However, if you decide to take that route, be sure to find advisors who are well versed in setting one up according to IRS rules.