What happens when someone dies and their trust spells out how they want to distribute things, but their IRA or 401(k) beneficiary designation says something else?
The IRA or 401(k) beneficiary designation trumps the trust.
This came to life recently with a new client. His wife passed away last year. Her trust - and her wishes - were that everything get split 1/3 each to her husband and 1/3 each to each of her children (children from a previous marriage).
However, the bulk of her financial assets were in a company 401(k) account. The children were named as the beneficiaries at 50% each. The husband was not named.
I was speaking with the attorney who had drafted the trust and he was surprised to learn the trust had no authority over the 401(k) account. He seemed to think we could send the trust document to the 401(k) company and they would disperse the funds that way. Sorry, it doesn't work like that. The 401(k) company must follow what they have on record, and if someone wants to try to contest it, they can, but it may be a cumbersome process.
Your trust has no authority over your IRA or 401(k) account unless you name the trust as the beneficiary of that account, and if you do that, you need to make sure your trust is drafted properly to account for the rules that come along with IRA accounts. If the trust isn't drafted to account for this your beneficiaries may lose valuable distribution options, such as stretching the IRA distributions out over their life expectancy, and instead be forced to accelerate their withdrawals.
Now, you would think your estate planning attorney would consider all of this, but many do not. I think it's because they do not have real-life experience in dealing with brokerage firms, account titling, and beneficiary designation forms.
They draft a beautiful trust document, which works fabulously well for all accounts that can be re-titled into the trust. Yet for each account that requires a separate beneficiary designation (life insurance policies, ROTH IRAs, Traditional IRAs, and any company-sponsored retirement accounts like 401(k)s, 403(b)s and 457s), in order for the trust to have authority you would have to fill out a new beneficiary designation that names the trust as the beneficiary - and this isn't always the best way to accomplish your estate planning goals. Sometimes it makes sense to leave some of these types of accounts directly to a beneficiary rather than passing them through the trust.
One additional estate planning problem I see are trusts that don't consider the practical aspect of how much money may actually be left in the trust for a beneficiary on down the road. It is usually cost prohibitive to have a corporate trustee who is required to control distributions on a relatively small amount of money.
A good estate planning attorney should look at your net worth statement, and how much you have in which types of accounts, and draft documents that make sense based on your financial situation. They should also help you figure out how each account should be titled and how to restructure the beneficiary designations on accounts and life insurance policies that require this. Estate planning is more than just a set of legal documents. You have to take the next step to make sure those documents will apply to the accounts you want them to apply to.
An estate planning attorney should also realize if your trust structure is likely to leave only $100,000 or $200,000 in a trust with a corporate trustee that is supposed to slowly disperse the funds over a younger beneficiary's lifetime, that may not be practical.
Learn more: How Beneficiary Designations Trump Your Will