When to avoid naming a trust as the beneficiary of your pension plan


Naming a trust as the beneficiary of your retirement plan can be a good idea in certain circumstances, but it can be dangerous if you’re worried about creditors attacking your estate.

There are many good reasons to designate a trust as the beneficiary of a retirement plan, whether it’s a 401(k), 403(b), or IRA. If the IRA beneficiaries are young, disabled, or for other reasons should not manage the asset themselves, the trust provides that management. People in a second marriage or relationship may want their spouse or partner to benefit from the funds, but cannot exhaust them entirely, and trusts provide protection from the beneficiary‘s creditors. However, the trust may not protect your retirement funds from your own creditors.

Creditor protection for pension plans
IRAs have substantial creditor protection over your lifetime. If you are sued, your IRA will be subject to a claim, but you can protect it by declaring bankruptcy. Under the federal bankruptcy code, the first $1,362,800 of retirement assets are protected from payment to creditors. Most cases settle, so you can usually get this protection without having to go through the bankruptcy process, but it’s there if you need it.

But only during life
However, this coverage ends upon death. This does not apply to inherited IRAs, those that you leave to others or that you inherited from others. Inherited IRAs are subject to creditor claims. However, your heirs are not responsible for your debts. So if your retirement plans are transferred directly to them, the assets of the plan will be protected from your debts.

As an example, suppose an individual dies owing $400,000 to various creditors, with a total estate of $500,000 split between a home with a market value of $250,000, savings of $100,000 and pension plans holding $150,000. If pension plans are paid directly to that person’s heirs, they will not be subject to that person’s debts. The rest of the assets will have to be used to pay off debts, leaving nothing in the estate for the heirs, but also leaving creditors short by $50,000.

Revocable Trusts Subject to Claims
But what if IRAs were payable to the individual’s revocable trust? So they can very well be the subject of a complaint. If there are not enough funds in the deceased’s probate estate to pay their debts, states often allow creditors to seek a revocable trust. In at least one case in Kansas, which like 34 other states and the District of Columbia has adopted the Uniform Trust Code, the court held that this right of creditors to sue the deceased’s revocable trust applied to a payable IRA. to the trust. There is no reason to think that other courts would not come to a similar conclusion.

So if your debts exceed your pension plan assets, don’t have your pension plan pay your revocable trust. Make it payable directly to the beneficiaries or, if a trust is needed, to an irrevocable trust. If your assets far outweigh your debts or possible lawsuits against you or your estate, don’t worry about the above.

Last modification: 02/18/2022

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