Have an Adult Child Who Is Terrible With Money? About Using a Trust for Your Retirement Accounts

I've been lucky enough to professionally help people retire for over 36 years now and it goes with the territory that I've seen beloved clients die and I've assisted in the estate settlement process to help distribute their life savings to their heirs. It's been my experience that most heirs to retirement accounts understand and respect the diligence, discipline, and skill that was needed to amass even a small fortune and many often continue to have Latitudes manage the funds that we helped their benefactors accumulate.

Every once in a while I meet an heir who just can't spend the money fast enough, someone who doesn't understand the power of long term investing and the miracles of compound interest and only sees the inheritance as a windfall to be spent on material possessions and immediate gratification, the type of things that my clients had gone without in order to accumulate their wealth. In many cases, before they died, my clients were aware of this potential and felt as though they are helpless to prevent their life savings being spent on luxuries that they never afforded themselves.

I'm not judging these heirs, its just that some people are not savers and I can tell from the beginning who is going to drain the account and who is going to see the opportunity of using their inheritance to continue to invest wisely.

Money is funny like that, some people are good with it, some people are better at spending it. If you are worried about your heirs blowing through your nest egg, there are some legal choices that you can make in the estate planning process and; with retirement plans you can often address your concerns by implementing a trust as the beneficiary of your IRA.

Let me be clear: You cannot put your individual retirement account (IRA) in a trust while you are living. But you can name a trust as the beneficiary of your IRA and dictate how the assets are to be handled after your death. This includes traditional, Roth, SEP, and SIMPLE IRA accounts. If you establish a trust as part of your estate plan and want to include your IRA assets, it is important to consider the rules and the tax consequences associated with certain transactions.

Important Points:

You cannot put your individual retirement account (IRA) in a trust while you are living.

You can designate a trust as a beneficiary of your IRA and state how the assets are to be handled after your death.

Taxes can be an issue, it is crucial that the trust be set up properly.

Overall a Trust is not an effective way to save income taxes, the government is going to get their share of taxes overtime.

Advantages of a Trust Beneficiary

Naming a trust as the beneficiary to an IRA can be advantageous because owners can dictate how beneficiaries use their savings. A trust instrument can be designed in such a way that special provisions for inheritance apply to specific beneficiaries—a helpful option if beneficiaries vary greatly in age, or if some of them have special needs to be addressed. As I mentioned: Many people also believe the trust provides tax savings for beneficiaries, but that is rarely the case.

Important factors to consider are how beneficiaries take possession of the IRA assets and over what time period. Seek advice from a trust adviser well-versed in inherited IRAs. To gain the maximum stretch option (in other words how long you can leave funds in an inherited IRA to continue to defer taxes) for the distribution of the account, the trust must have specific terms such as "pass-through" and "designated beneficiary." If a trust does not contain provisions for inheriting an IRA, it should be rewritten, or individuals should be named as beneficiaries instead.

Disadvantages of a Trust Beneficiary

Although moving all assets into the name of a trust and designating it as the beneficiary on retirement accounts is commonplace, it is not always a good decision. Trusts, similar to other non-individuals that inherit IRA assets, are subject to accelerated withdrawal requirements, most often within five years from the original IRA owner's death.

If the "pass-through" trust rules are applied by the IRS, the IRA assets must be withdrawn within a 10-year period. (An exception is made if the trust beneficiary is an eligible designated beneficiary. An eligible designated beneficiary includes a surviving spouse, a disabled individual, a chronically ill individual, a minor child, or an individual who is not more than 10 years younger than the account owner.) If the "pass-through" trust rules do not apply, the IRA assets will need to be withdrawn within a 5-year period.

Depending on the size of the account, this could place a burden on beneficiaries. Particularly detrimental is eliminating the spousal inheritance provisions by naming a trust instead of a spouse as the beneficiary (you probably shouldn't do that).

While trusts can streamline most estate-planning areas, they can create more paperwork and even additional tax burdens for beneficiaries of an inherited IRA. Work closely with an estate planner, attorney, and accountant, who are all knowledgeable about trusts and IRAs, to maximize your legacy.

In combination with a well written will and other estate planning provisions (like life insurance, proper naming of beneficiaries, spousal inheritance of IRA's, etc.) you can take some steps towards helping to preserve your life savings and helping to possibly prevent a spendthrift heir from going through your estate.

I sometimes tell clients who know their kids are bad with money to have a little fun! Take the kids to Europe, go on that cruise, make donations to charities that you care about while you are alive! From my experience, I'd rather see my clients have some benefit from all their hard work instead of their kids' sailboat dealer!

In general, most people have responsible children who hve learned to take care of their money from their parents and, besides... ultimately, it is none of my business what anyone decides to do with their own money! But: if you are worried about preserving your assets for your Grandchildren's education or some other long range goal, a little bit of money spent with an estate planning attorney can go a long way towards taking care of your assets for the long term.

(Some of the facts in this article were drawn from Investopedia.com. I highly recommend working with an attorney who is an expert in estate planning or elder law to draw up these plans!)

Rick DiBiasio CFP (TM)

Founder, Latitudes Fianancial

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This information is not intended to be a substitute for individualized legal advice. Please consult your legal advisor regarding your specific situation. 

Latitudes Financial Strategies and LPL Financial do not provide legal advice or services.