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Understanding How Retirement Trusts Work


Couple discusses a retirement trust with their financial advisorInvestors often use trusts to protect their assets and exert control over their estate after they’ve passed away. The problem with trusts is that you cannot place your retirement account within them. However, a retirement trust is a strategy that could protect your estate for your beneficiaries and lower your tax liability. Here’s what you need to know.

Consider working with a financial advisor as you do estate planning or update an existing estate plan.

What Is a Retirement Trust?

A retirement trust is a strategy where you name your trust as the beneficiary of your retirement accounts. This offers the best of both worlds. The tax benefits of a retirement account and the protection of a trust.

A retirement trust is a good idea for investors who have sizeable retirement account balances and want to control the distribution of those funds through a trust. These accounts also offer numerous protections for average investors that can ensure that your estate doesn’t lose your lifelong savings to a lawsuit, bankruptcy, divorce or spendthrift beneficiary.

How a Retirement Trust Works

To establish your retirement trust, you’ll create a special trust designed to receive some or all of your retirement account proceeds upon your death. In your retirement account, you’ll name the retirement trust as a beneficiary. Depending on the size of your estate and your financial goals, you can designate some or all of your retirement plan proceeds to the retirement trust.

When you pass away, the designated portion of your retirement plan transfers to the retirement trust. The retirement trust is designed specifically to navigate retirement planning and tax rules to minimize taxes and provide additional benefits. Your heirs receive distributions from the retirement plan according to required minimum distributions (RMDs), tax laws and your trust decisions.

Tax status 

Trust document being signedNormally, distributions from a retirement plan are taxable. However, when set up properly, renaming the assets into the trust upon your passing is not a taxable event. Since trusts are known to pay taxes at high rates and many beneficiaries are in low tax brackets, it is best to make the beneficiary responsible for the income tax due upon withdrawal from the trust.

Beneficiary protections 

Yes, retirement trusts offer many of the same protections as trusts, which is why many say that they are the best of both worlds. A few of the protections that a retirement trust offers include:

  • Ensuring that a spendthrift beneficiary doesn’t blow their inheritance
  • Sheltered from a beneficiary’s divorce proceedings
  • Protecting assets from a lawsuit against a beneficiary
  • Shielding assets in case of bankruptcy
  • Minimizing taxes by stretching out payments
  • Avoiding asset and income limitations for disability assistance

How beneficiaries receive money from a trust

Just like other trusts, proceeds from a retirement trust can only be distributed to beneficiaries or to make payments on behalf of them. If your children are old enough, they may become the trustee of the retirement trust. Or, in the case of spendthrift children, you can choose someone else to manage the trust on their behalf.

The trust is subject to required minimum distributions (RMDs). Each year, the trustee must make RMDs to the beneficiaries each year. Additional withdrawals may be made from the trust if they are in accordance with the rules you set in place.

The Bottom Line

Grandmother and granddaughterInvestors spend their working years to build a nest egg that not only takes care of their retirement but also creates financial wealth for generations. With a retirement trust, those assets can continue to grow tax-deferred and enjoy numerous protections for your family’s retirement plan assets. To establish your retirement trust, it pays to work with a qualified advisor who understands the nuances of this strategy to avoid unintended taxes and risks to your assets.

Tips on Retirement

  • Asset allocation is one of the primary factors in determining your portfolio’s annual performance. Our asset allocation calculator helps investors understand how different portfolios perform over time and understand the risks of investing in stocks and bonds.
  • Investors can grow their portfolios and reduce risk by creating an asset allocation strategy with advisors. Advisors can customize the investing approach based on your tolerance for risk, goals and timeframe. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

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