Why Trust Funding and Beneficiary Designations Matter in Estate Planning

Preparing and executing a proper estate plan is only part of the larger picture. Effective estate planning also requires careful trust funding to ensure that assets pass according to the client’s intentions and avoid unnecessary probate. After a client works with an attorney to formulate a specifically tailored estate plan and trust agreement, the attorney and client must continue to work together to properly fund the client’s trust and coordinate beneficiary designations across all assets.

A client’s specific situation may warrant a different plan for funding, but for the most part the following guidelines should be followed.

Deeds for the client’s real property should be prepared and executed to place the property into the name of the trust agreement.

Bank accounts and investment accounts should be titled in the name of the trust or, at a minimum, made payable on death to the trust agreement.

Life insurance beneficiary designation forms should be updated to name the trust agreement as the beneficiary, when appropriate.

Business interests and LLCs should be properly assigned to the client’s trust and must be transferred in accordance with the provisions of the governing documents of the business.

Keep in mind that joint accounts and accounts with designated living beneficiaries avoid probate.

Naming beneficiaries for a client’s IRA and 401(k) retirement accounts is more complicated. Retirement plans benefit from deferred taxation, meaning that contributions and investment earnings are not taxed until distributions are taken. A surviving spouse may roll over retirement accounts inherited from a deceased spouse into the spouse’s own retirement account and delay required minimum distributions until the applicable required beginning age under current law.

For most non-spouse beneficiaries, however, retirement accounts inherited after 2019 are subject to the SECURE Act’s 10-year distribution rule, which generally requires the entire account to be distributed within ten years of the account owner’s death. Certain eligible designated beneficiaries, such as disabled or chronically ill individuals, minor children (until they reach the age of majority), or beneficiaries not more than ten years younger than the decedent, may qualify for different distribution rules.

In many cases, it is appropriate to name the client’s spouse as the primary beneficiary of a retirement account and the client’s trust as the contingent beneficiary. This approach is often used when clients have minor children or beneficiaries who may not be able to responsibly manage large distributions. In these situations, the trust must contain specific provisions that allow the IRS to “see through” the trust to the underlying beneficiaries in order to preserve favorable tax treatment where available.

Care should be taken when naming a charity as a partial beneficiary of a retirement account or as a beneficiary of a trust that is funded with retirement assets. Improper structuring may accelerate required distributions for individual beneficiaries and eliminate favorable distribution options, resulting in unintended tax consequences.

Another situation requiring careful planning is naming a special needs individual or a third-party special needs trust as a beneficiary of a retirement account. While certain special needs trusts may qualify for favorable treatment under current law, retirement accounts are often better directed to non-special-needs beneficiaries, with the special needs trust funded using non-qualified assets or life insurance. This approach can help preserve benefits eligibility and minimize adverse tax consequences.

The bottom line is that beneficiary designations for retirement accounts are complex and highly fact-specific. Clients are strongly encouraged to consult with their attorney, tax advisor, and financial planner when making these decisions.

Clients are also encouraged to annually prepare and update a list of assets owned so that, in the event of incapacity or death, successor agents and trustees have a clear understanding of the client’s assets. If a client is comfortable sharing financial information with his or her children, a family meeting may be appropriate to communicate relevant information to the next generation.

If new real estate is acquired or a new account is opened, those assets must be properly coordinated with the trust agreement and beneficiary designations.

Estate planning documents and beneficiary designations should be reviewed every three to five years and updated as circumstances change. Too often, probate proceedings become necessary due to incomplete trust funding or outdated beneficiary designations, such as when a spouse predeceases the retirement account owner and no contingent beneficiary has been named. Clients are also encouraged to retain copies of beneficiary designation forms and to provide copies to their attorney for reference.