Russell W. Hall, CFP®

It’s a common scenario – while reviewing estate planning for new clients, we notice that they have listed their revocable living trust as the primary beneficiary on their IRA, Roth IRA, or other retirement accounts. When we ask why, the answer is usually something along the lines of “We don’t know, our attorney just told us to do it that way.”

A Good Reason

This is entirely understandable. In California, where our financial planning firm is located, the probate process is lengthy and expensive. A good estate planning attorney with the knowledge and experience of walking through that process will want heirs to avoid it, and one of the main ways to avoid probate is to establish a trust.

A quick aside here – simply having a revocable living trust document with a list of assets does not mean those assets are “in the trust”. Each asset needs to be titled in the trust name in order to truly be owned by the trust and avoid probate. For instance, the title on a taxable brokerage account should read “Smith Family Trust dtd 1/1/21” and not “John Smith & Jane Smith Community Property”.

Beneficiaries

Retirement accounts like IRAs and 401(k)s can only be owned by individuals (for the most part, although we’ll talk about inherited accounts a little later) and can’t be owned directly by a trust. They also pass by beneficiary designation, and thus usually avoid probate anyway. One exception would be someone listing “my estate” as the beneficiary – that’s a pretty sure one-way ticket to probate, and something you should really avoid if you live in California or many other states.

There are any number of horrifying stories about the power of the beneficiary designation and the dangers of not keeping beneficiaries updated. Essentially, the beneficiary designation on retirement accounts outweighs any other estate instructions, including wills. If someone names their third child as the sole beneficiary of their IRA, that money will almost always end up in that child’s hands - at the exclusion of everyone else, including the spouse.

So, many estate planning attorneys instruct their clients to list the trust as primary beneficiary. It’s as close as you can get to having those retirement accounts owned by the trust, and since the trust has detailed instructions on how the money should be divided, why not utilize it for retirement accounts too?

Potential Problems

As with many things, you often don’t know there’s an issue with estate planning until it is actually put to use (when it’s too late to fix, or at best expensive and time-consuming to do so).

For married couples who want their assets to pass to each other, naming the trust as primary beneficiary can complicate things unnecessarily and limit the surviving spouse’s options. This is often especially true if the trust documents haven’t been updated in some time, with outdated instructions on splitting assets.

Instead, we suggest naming each spouse as primary beneficiary, which lets the surviving spouse treat those retirement accounts as their own and not as inherited accounts. This particularly matters when calculating required minimum distributions – the surviving spouse can spread those over his or her own lifetime, instead of being forced to withdraw all of the funds within a ten-year period.

For the Kids

When considering whether to name your children as beneficiaries – either as primary (if you’re single or choosing to leave that asset to them) or as secondary – it helps to think through what you want to have happen.

For couples with minor children, it’s a pretty easy decision to name the spouse as primary and the trust as secondary (also called contingent). The revocable living trust is great for listing a guardian for the children should both parents pass away, a trustee who can manage assets on their behalf, and can spell out the terms for when the children will receive funds outright.

For couples with grown children, it gets a little more complicated. Again, most attorneys will default to naming the trust as secondary, but that can cause problems similar to those we outlined for the surviving spouse.

We take the approach of first reading through the trust. If the document states that the kids get everything outright, free of trust, we suggest naming them as beneficiaries and leave the trust out of the picture. That lets each child eventually wind up with their own inherited IRA or Roth IRA, after a relatively simple process.

If the funds will stay in trust for some reason and not pass to the children outright, then naming the trust as beneficiary is appropriate. There are many situations where this could be the case, such as special needs, substance abuse, or second marriages. Also, remember that it’s not an all-or-none situation – you could name some kids outright and leave others their portions in trust.

Final Thought

We hope that, if nothing else, this article will prompt you to go double check the beneficiary designations on your retirement accounts (or really any account with a beneficiary). If you’ve named your trust as either a primary or a secondary beneficiary, consider some of the issues we’ve raised here and make sure that’s the best choice for your goals.

We are also happy to help you think through your estate planning. Schedule a 15-minute discovery call with a fee-only financial advisor.