A Strategic Guide to Individual vs. Trust Designations

One of the most important decisions in estate planning is choosing the beneficiaries for your retirement accounts (such as your 401(k), IRAs, or 403(b)).

The two primary options are to name an individual directly or to name a trust. It is important to understand the key differences between the two in order to make an informed decision that aligns with your goals. 

Naming an Individual as Your Beneficiary

The most common and straightforward approach is to name an individual, such as a spouse, child, or other relative, on the beneficiary designation form. 

When This Option Works Well

• Simplicity and Ease: This is the simplest path. No additional legal documents are needed beyond the beneficiary form itself. 
  
• Maximum Flexibility for a Spouse: Naming your spouse provides them with unique advantages. They can roll over the inherited account into their own IRA, allowing the funds to continue growing tax-deferred and delaying required distributions until they turn 73. 
  
• For Responsible Adult Beneficiaries: If your beneficiary is a financially responsible adult and you have no concerns about their ability to manage a large sum of money, this works well. 

Potential Downsides to Consider

• Absolute Control by Beneficiary: Once your beneficiary inherits the account, the money is theirs to do with as they please. They could withdraw the entire amount at once, triggering a significant tax bill and depleting the inheritance quickly. 
  
• Special Needs Planning Risks: Inherited retirement accounts are generally included in the beneficiary's estate and personal assets. This can jeopardize an individual's eligibility for government benefits, so it is crucial to understand whether the intended beneficiary is eligible for such benefits.

Naming a Trust as Your Beneficiary

This is a more complicated strategy that involves naming one or more trusts as the beneficiary of your retirement account. The trust document then outlines your specific instructions for how the assets should be managed and distributed to your beneficiaries. 

When This Option Works Well

• Planning for Complex Situations: A trust can be essential if you have beneficiaries who are minors, have special needs (as it can be structured to avoid disqualifying them from government benefits), or struggle with managing money. 
  
• Protection for Your Beneficiaries: Assets held within a properly structured trust can receive a layer of protection from a beneficiary's creditors, lawsuits, and claims in a divorce. 

Potential Downsides to Consider

• Complexity and Cost: Establishing a trust requires careful legal drafting and carries upfront costs. You will also need to appoint a trustee (an individual or a professional institution) to manage the trust after your death. 
  
• Tax & Distribution Rules: For the trust to work effectively for a retirement account, it must be drafted to meet specific IRS rules. If not, it can lead to accelerated tax payments and negate some of the tax-deferral benefits afforded to retirement accounts. The SECURE Act of 2019 already requires most beneficiaries to withdraw funds within 10 years, and a trust must be carefully structured around this rule. Improperly drafted trusts can result in 5-year distribution requirements. In addition, income tax rates are compressed at the tax level, meaning that trusts are taxed at the highest rate after just $15,650, as of 2025. Depending on the type of trust, there may be significant income tax liabilities that would otherwise be avoided with different beneficiary designations. 

For more information on Estate Planning and Trust Services, contact BakerAvenue to discuss how we can help determine which type of beneficiary is right for you.