A trust for a 401(k) account is ideal if any of the following scenarios applies to you:
Your beneficiaries are young children or grandchildren, or a person with special needs.
Your beneficiaries have drinking, drugs, gambling, or creditor problems.
You have remarried and want to ensure your second spouse and/or children receive their due.
Your beneficiaries have poor financial sense and cannot be trusted with a large sum of money.
You don’t want your assets to become part of your spouse’s “estate” – potentially subject to taxation.
It is possible to roll the funds into an IRA to ensure that only the Required Minimum Distributions are paid out to recipients named in the trust,
The trust document directing that the monies received from the retirement account be distributed is how taxes are avoided at the trust level.
Potential Disadvantages of Designating a Trust as a 401(k) Beneficiary
The assets will be subject to Required Minimum Distributions: The primary disadvantage of naming a trust is that the retirement plan assets will be immediately subjected to RMD payouts, calculated based on the expected lifespan of the oldest beneficiary. When there are multiple beneficiaries, the younger ones will then lose out on their ability to earn deferred interest.
Uncle Sam may want his cut straight away: Employers can prohibit trusts from receiving periodic 401(k) payouts, meaning all the deferred taxes will be due on the full 401(k) balance within one year of your death, when the money is inherited. If your employer’s plan does not permit life-expectancy payouts to a trust beneficiary, you may consider rolling over the 401(k) balance into an IRA that specifically allows it.
You must leave your money to a person: The IRS has rules about trust beneficiaries. For instance, the 401(k) must go to a person or group of people. You can’t, for instance, leave your assets to a charity, your church, or any other non-specific entity. You may also need to designate a contingent secondary beneficiary who will receive the remaining assets should the primary beneficiary die before all funds have been distributed.
Trust setups require a bit of paperwork: Valid trust beneficiaries must qualify under state laws. They must be named specifically in the trust document, and a copy of this document must be filed with the 401(k) plan administrator. Under IRS rules, a will cannot override a beneficiary designation form, so you will want to be sure of your wishes.
