Beneficiary Designations and Trusts: One Size Does Not Fit All

Transferring a retirement account to beneficiaries seems simple enough. Certainly your fund manager or financial planner will tell you it is—all you have to do is fill out the beneficiary designation form they provide to you. But is it really that simple? Well, in a sense yes. If you complete the beneficiary designation form by naming your beneficiaries directly (e.g., equally to my son Bob and daughter Jane), the names on the form, along with the terms of the underlying contract (and if you are a glutton for self-abuse, try reading one of these!) controls. And this is simple and safe for the retirement plan manager, because it means they do the same thing all the time. But what about you?

SO WHAT’S IN IT FOR THEM? Two things. Simplicity and the Avoidance of Risk. By getting you to name beneficiaries on their form, pursuant to the terms of their contract, they control the outcome. And they limit the work they have to do and, more importantly to them, their exposure to risk. They know their contract and their rules. And they are all terribly litigation-averse (meaning that they really, really, really don’t want to do anything that might land them in court.)

But what happens if:

• Your beneficiary is a under 18? State law says they cannot have the retirement benefits, and the courts and the fund contract will control what happens next, but will probably be at best both expensive and a pain.
• Your beneficiary dies before you do? The plan contract will determine this, and it may not be what you would decide.
• Your beneficiary is about to be divorced, lives in a community property state, has just filed bankruptcy, has judgment creditors or other problems? The answer, of course, depends on a lot of factors, but long-story-short the beneficiary could well lose some or all of the money.

But all of these scenarios present problems for YOU and YOUR HEIRS, not the retirement plan manager. All they have to do is abide by the terms of their contract and they are golden.

SO WHAT’S IN IT FOR YOU? Well, if you would like to control what happens if an heir dies before you, if you would like to limit the ability of your heirs’ creditors to get to your heirs’ inheritance, and if you would like to avoid complications if you have an heir under 18, you can name a TRUST as beneficiary of your retirement plans.

Now if you do this, it is CRITICAL that you have a well-drafted trust and have thought through all of the implications of doing this along with the possible outcomes. Some sources will tell you that this exposes your retirement benefits to YOUR creditor claims and to adverse tax implications. Both are true IF your trust is NOT properly planned, drafted, and funded. So this is not the place to save a few bucks—if you are going the trust route it is worth it to do it right. But if properly set up, a trust can work VERY WELL as beneficiary of retirement accounts and solve many problems.

Some financial planners and fund managers will discourage this. The reasons include those we mentioned above. And some have seen the disaster of poorly drafted trusts and since they are not really qualified to tell the difference between good and bad the straight beneficiary designation is just safer for them. Sometimes they just have out-of-date information. And most of them simply don’t understand trusts. But that is okay, I don’t understand some financial products. We each have our field.

So should your trust automatically be the beneficiary of your retirement plan? No. But if you have a trust it may be an option you should consider. Trusts are a common estate-planning tool, but are not appropriate for everyone. And even if you have one, and it is properly set up to handle retirement benefits (not all are), it still may not be the thing to do. Or you may want a separate trust just for the retirement benefits.

The point is that it should not be an automatic thing to name the trust as beneficiary, but NEITHER should naming beneficiaries directly be automatic. Everybody’s situation is unique, and the key term in Estate Planning is PLANNING. Sometimes life is complicated, and this is one of those times. Any one-size-fits-all approach is deficient by definition. Don’t fall for it.

Image credit: Andrew E. Larsen