Retirement Plan Trusts: What Are They and How Do They Work?

Retirement plan trusts (RPTs) are standalone, revocable trust arrangements whereby the retirement accounts (traditional and Roth IRAs, 401(k), 403(b), and other “qualified” plans) received by a beneficiary are administered for the lifetime of the beneficiary. In general, the beneficiary himself or herself is allowed to be the trustee.

The RPT is:

• An asset protection trust, protecting the beneficiary against hypothetical risks to the enjoyment and use of the distributions. A Retirement Plan Trust is a form of “spendthrift” trust but the beneficiary does not need to be a person who can’t handle money in order for the trust to be effective.
• A possible recipient of the estate tax exemption amount (presently $1 million in Massachusetts and over $11 million federally) for the benefit of the surviving spouse and the family.
• A possible generation-skipping transfer tool.

The trustee has discretion to benefit the primary beneficiary and no one else, especially not creditors and others who would like to make claims against the assets. The trustee may pay out to the primary beneficiary to assist in his or her family’s education, housing, health, and leisure, but family members are themselves not beneficiaries. 

Because the trustee of a retirement plan trust is prohibited from making payments or distributions to anyone other than the beneficiary or for his or her benefit, the trustee cannot be compelled in a lawsuit, divorce, collection, Medicaid application (other than for the spouse) or in other settings to make distributions. The principal objective of a retirement plan trust is to provide this asset protection structure.

The trustee of a retirement plan trust must use the assets strictly for the benefit of the beneficiary and cannot pay to the creditors of the beneficiary. The trustee cannot:

• split the beneficiary’s retirement plan distributions payable to the trust with a divorcing spouse
• pay the beneficiary’s debts (creditors) directly
• pay out funds in the event of a dispute (lawsuit) against the beneficiary
• use the funds in a way that would disqualify the beneficiary from public or private benefits in the event of disability 
• allow the beneficiary to destructively spend the assets because they are to be used and/or preserved for the beneficiary’s benefit

We refer to divorce, debt, disputes, disability, and destructive spending as the “Killer Ds” – five categories of risk that the trustee is empowered to avoid. 

A retirement plan trust can also be written to make the beneficiary responsible for the income tax due upon withdrawals from the account. This is preferable in many cases since trusts are known for paying taxes at high rates while the trust’s individual beneficiaries are often in a lower tax bracket.

A retirement plan trust qualifies as a shelter for the estate tax exemption of the first spouse to die. When there are insufficient other assets to fill up the exemption, we can look at using the RPT for this purpose and not lose the use of the full exemption. For beneficiaries other than the spouse, the trust may also skip a generation for estate tax purposes, saving more taxes.

The beneficiary of the retirement plan trust can expect that the assets will be used to supplement his or her income and property. Thus, the trust would commonly pay all of its income to the primary beneficiary.

Although the beneficiary will have to pay income tax on the distribution, principal may be distributed for support purposes such as paying off personal loans, credit cards, paying down or paying off mortgages, educational expenses, weddings, special events, getting started in business, down payments and deposits for major purchases such as homes or second homes, business interests, enhancing one’s income, especially in retirement and during other periods of unemployment or disability, and the like. The RPT can be used to enhance and augment the lifestyle of the beneficiary, without regard to other assets available to the beneficiary.

Retirement plan trusts can also be used for similar expenses for a beneficiary’s spouse and dependents. The key to the success of protecting assets inside the trust is maintaining the independence of the trustee regarding distributions that might benefit anyone else. In other words, no one else can require the trustee to make distributions to or for the benefit of other persons besides the beneficiary. As such, it is often wise to install an independent trustee over the RPT to remove conflicts of interest in handling the trust assets.

Carefully written retirement plan trusts are useful estate planning tools that can be used in light of the 2019 SECURE Act. (Reminder: This law impacts how qualified retirement accounts can be distributed.)