All too often, the income we anticipate in retirement is not the income we receive. This is not due to failing to save enough to retire on, it is due to the lack of consideration given to the cause and effect of taxation on the withdrawals taken as retiree income. We all need to remember that there is always a silent partner in our retirement savings plans, whether they be an IRA, SEP, 401k of any other IRS sponsored form of investment or accumulation vehicle. That partner’s right and proper name is The Department of the Treasury, and we see it exhibited in our lives as the Internal Revenue Service. When we begin our retirement savings in a tax qualified way, we do so for three reasons. One, we simply want to retire eventually and have a decent lifestyle. Two, we understand that no one else will provide for us in retirement, and that is a great motivator in itself. Three, we get a TAX BREAK for saving in a qualified retirement plan. That means we do not pay current income tax on all monies deferred in our qualified plan, and that makes for a great incentive to save. No tax on the contributions, no tax on what may be decades of compound interest as the assets grow. In fact no tax until you withdraw the money as income after you retire. Therein lies the trouble.
The primary reason for establishing a trust is not necessarily to defer or avoid taxation, as that is not one of the benefits of the common “Living Trust” that so many Americans have created to receive and manage their estates after death. In many instances, a trust is designed to avoid the taxation on a decedents estate, however, since the threshold for that requirement exceeds 5 million dollars for an individual, and ten million dollars for a married couple, using a trust for such a purpose is not in the offing for the vast majority of Americans. More often than not the reason for a trust is simple. Post mortem CONTROL of the assets in a manner the decedent saw fit during their life. The problem created by utilizing a trust as the beneficiary for an IRA is that the rules for distribution of qualified assets, such as 401k’s, 403b’s, IRA’s and other tax deferred, and therefore tax infested assets, are so greatly different from the distribution of other assets in an estate. For the sake of simplicity, we will refer to all qualified plans from this point on as IRA’s. IRA’s do not pass by trust, will or any other external method of distribution. They are subject in their entirety to their BENEFICIARY ARRANGEMENT. The specifics of transfer that are inclusive in the beneficiary arrangement are subject to the conditions stipulated by the PLAN CUSTODIAN. So many times, IRA owners have placed these assets in wills, trusts and other legal documents designed to distribute them at death, to no avail. This commentary is in regard to using a trust as a beneficiary.