When discussing an estate plan, there is almost always an important question from people around what to do with their retirement accounts. They tend to be one of the major assets for an individual and it makes sense to want to protect them with a powerful legal tool like a trust. However, while you are living you cannot place your retirement accounts directly into a trust. But, as you may have guessed since we are still in the first paragraph, that does not mean the discussion stops there. Even though the retirement accounts cannot go directly into the trust, it is worth strategizing to determine the best approach to ensure the protection and preservation of those assets. The first question we have to address is whether those retirement accounts are tax deferred accounts or not.
What is a tax deferred account?
Initially, we should be clear on what a tax deferred account is. This refers to an account where you have not paid taxes on the money that has been placed into that account, an advantage afforded to accounts like your 401(k) or a Traditional IRA. However, it is important to emphasize that it is tax deferred and not tax free. It is deferred because someone, someday, is going to pay tax on that money when it is withdrawn. That may be you paying tax on that money as it is withdrawn in your retirement, or it will be your beneficiaries paying tax on it as they are required to withdraw it after they inherit the account.
This is in contrast with an account such as a Roth IRA, where you have already paid tax on the money invested in the account. If your retirement assets are housed in a Roth IRA currently, then you have a lot more flexibility with how you manage that account. Even though the specific Roth IRA account cannot be placed into the trust, those assets you have invested in the Roth IRA can be moved into an account within the trust without having to pay the same penalties or level of tax that is due on a tax deferred account.
Can my tax deferred account be placed directly into a trust?
No, that tax deferred account cannot be transferred directly into your trust. But that does not mean those assets are destined to count against you for medicaid qualification purposes, or that those assets do not have an avenue to protection and preservation.
The main consideration at this stage is going to be defining your goal with those assets. If your planning does not include medicaid qualification then your estate plan could rely on ensuring there are beneficiaries on your accounts so that the assets do avoid probate. But it is worth considering the value of a program like long term care medicaid and the thousands of dollars that have to be spent every month for long term care. Factoring in the value you receive compared to what it would cost to transfer your assets out of a retirement account into your trust allows you to reach a decision that makes the most sense for you.
Are the tax consequences the same if I or my beneficiaries withdraw the assets from my tax deferred account?
The amount of tax paid is very likely to be different depending on who is withdrawing the assets. As I stated at the outset here, someone has to pay the taxes on your retirement account someday. The likely options are either you pay them during your life by withdrawing the assets yourself or that your beneficiaries pay them as they make required withdrawals after inheriting it.
Legislation was passed at the federal level in 2019, called the Secure Act, that requires beneficiaries of a tax deferred account to withdraw those inherited funds over the span of a ten year maximum period. This ten year deadline is critical to be aware of for planning purposes because what that really means is that the assets in your tax deferred account may be more valuable to you than they will be to your beneficiaries when the rubber meets the road. This is because you are not required as the initial investor to withdraw that entire asset over the course of ten years. Additionally, it is assumed that when you are making most of your withdrawals from that account you are retired. Making withdrawals during retirement means you are not earning additional income through a job and pushing your income tax rate to a higher level.
However, the flip side is that your beneficiary is likely to receive this asset during their working years and therefore they will be taxed on these withdrawals at a higher rate as it is added to their income. The ten year withdrawal requirement also limits the beneficiary’s ability to spread those withdrawals out over a longer period of time, consequently increasing the amount taken out each year and importantly, increasing the amount of taxable income to that individual.
THE BIG QUESTION
Is it the right decision to move my assets out of their tax-deferred status so that I can place them in my trust?
Here comes the classic lawyer answer, it depends! The answer here depends on your individual goals and circumstances. We are only here to recommend tools that fit your needs and will benefit you. There are absolutely scenarios where the right financial move is going to involve withdrawing those assets out of their tax-deferred status and placing them into your trust. That is because with your assets in a trust you are possibly setting yourself up to qualify for long term care medicaid to assist with paying for your expenses, limiting your tax liability from any changes to the estate and gift tax, and protecting those assets from other creditors or lawsuits so that they make it to the hands of your loved ones. If this question is one you are considering yourself, one of our attorneys would be happy to assess your specific situation and work with you to come to the decision that is best for you.
If you or your loved one has questions we would be glad to extend a FREE CONSULT to answer those estate planning and elder law questions and get your affairs in order. Let the experienced attorneys at McIntyre Elder Law help. Call (828) 233-5991.
Estate Planning & Elder Law Attorney
136 S. King St. Hendersonville, NC 28792