A Potential Tax Trap for Heirs

A disadvantage of retirement accounts is that they cannot be re-titled into a trust account. Doing so will cause immediate taxation of the entire account. Therefore, there is no estate planning document that directs the distribution of retirement assets. Instead, this is done by a beneficiary election form that often names a different heir then is named in the trust document, which causes serious problems for the heirs. 

To complicate things further, different types of retirement beneficiaries are subject to different IRS rules. For example, children are not allowed to roll the parents IRA over to their own IRA, but can establish another tax-sheltered account called an Inherited IRA.

Michael talks Inherited IRAs on Fox Business

Using trusts as beneficiaries can subject the retirement money to trust tax brackets in some states, which can trigger significantly high taxes. Leaving money to a charity through a retirement account beneficiary form can create powerful tax savings for other heirs since the charity gets retirement money tax-free, whereas heirs that are named persons do not.

Coordinating beneficiaries with estate plans is an important step toward successfully passing money to heirs with minimum tax consequences.