A trust is essentially a set of rules. Trusts serve a variety of purposes, but the primary purposes of trusts include avoiding probate, handling complex post-death distributions of assets (particularly in the context of blended families) and protecting assets from being counted as available under Medicaid eligibility (usually a part of nursing home or long-term care planning).
Traditional/simple IRA, Roth IRA and other tax-incentive-based retirement plans are retirement tools designed to provide tax advantages/incentives to position people to save money for retirement. Traditional IRAs hold “pre-income tax” money that can gain interest over time. The tax is only paid when the money is withdrawn from the account/plan.
Roth IRAs are funded with money for which income taxes have already been paid. That money can be withdrawn during retirement without being taxed at the time of withdrawal.
Because trusts and retirement accounts serve different purposes, people with a trust sometimes desire to place their retirement account in a trust.
The law is clear that a retirement account cannot be placed in a trust (made subject to the rules of a trust) while the retirement plan owner is alive. The public policy for this law is that the government wants people to use and live on their retirement plan investments when people retire. The incentives and tax benefits of retirement plans are not intended to serve as primary methods to pass wealth to future generations. Of course, some people do die before those people’s retirement accounts are paid out. However, the idea is that that circumstance should be the exception and not the rule.
Because the government desires that people use their retirement money in retirement, the government does not allow any extra rules (including the rules of trusts) to be imposed on those tax-benefited retirement plans.
Nevertheless, beneficiaries of retirement plans can be established to own retirement funds after the initial owner dies. In these circumstances, if the person who has the IRA or SEP dies with money in one of those accounts, the person’s beneficiaries (or heirs if no beneficiary is designated) can receive the remaining funds at the time of death.
Because retirement plans can designate beneficiaries, retirement plans can be set up to avoid probate. Thus, there is no need for a trust to help retirement plans avoid probate.
Notably, even though retirement plans cannot be “in” trusts while the retirement plan owner is alive, the retirement plan owner can name a trust as a retirement plan beneficiary. This can address a second value of trusts, which is the ability for money to be organized for more complex post-death distribution plans.
Unfortunately, assets to be protected from long-term care expenses (nursing home) via a trust must be in a trust for those assets to be protected. Because retirement accounts cannot be placed in a trust while the retirement plan owner is alive, the only way to use a trust to provide long-term care (nursing home) protection is to liquidate the retirement funds, which eliminates the tax benefits.
Lee R. Schroeder is an Ohio licensed attorney at Schroeder Law LLC in Putnam County. He limits his practice to business, real estate, estate planning and agriculture issues in northwest Ohio. He can be reached at Lee@LeeSchroeder.com or at 419-659-2058. This article is not intended to serve as legal advice, and specific advice should be sought from the licensed attorney of your choice based upon the specific facts and circumstances that you face.