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The Best Laid Plans
Dear Jeff:
What's the difference between a beneficiary on a bank account (IRA), or being a recipient of a trust?
Jeff Says:
Discussions about individual retirement accounts usually focus on the financial aspects of retirement, unfortunately to the exclusion of the estate planning issues. Yet, in my opinion, the estate planning issues are more complex and require greater attention.
For instance, at the death of the participant, the proceeds are, in fact, paid to a named beneficiary, as you correctly point out in your question. This provides a significant advantage over most other assets that we own individually at our deaths. These individually owned assets become part of our probate estate and pass to our heirs pursuant to the terms of our wills. There is, of course, some delay and expense associated with estate administration. Our heirs do not receive the property that goes through probate as quickly as they do the money they receive as the pay beneficiary of an IRA. A beneficiary designation is, in essence, a contract that supersedes your will and determines who will receive your IRA.
Beneficiary designation requires more than a passing thought. For instance, what happens if your named beneficiary dies before you or simultaneously with you? This issue is rather easily resolved by naming a contingent beneficiary. Keep in mind that the beneficiary will also have to pay income taxes on the IRA. More sophisticated planning, of course, is required to minimize the effects the income taxes will have on the beneficiary and may alter your choice of beneficiary for your IRA.
Estate liquidity is the final issue I will address with regard to the planning aspects of IRAs. We know that estates need money to pay probate fees, including executors' and attorneys' fees and inheritance and estate taxes. The potential problem is that our respective estates will not have sufficient cash to pay these expenses if our assets are comprised of retirement plans, life insurance policies paid directly to named beneficiaries, and illiquid assets such as real estate that often cannot be sold within a relatively short period of time. This too can be remedied, but it requires planning in advance.
The big difference between IRAs and trusts is the ownership of the underlying asset. Trusts contain beneficiaries--the individuals or organizations that will receive our property pursuant to the terms of the trust we created. In this respect, they are very similar to IRAs. The participant is the owner of the IRA, but the trust itself is the owner of the assets that have been contributed to the trust. The participant has complete control of the IRA, while the trustee, as a fiduciary, makes decisions for the trust and must follow the specific provisions set forth in the trust. There are many types of trusts and purposes for which each should be created, but this is a subject for another day. Suffice it to say for now, that naming a beneficiary might be the only similarity between IRAs and trusts.
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