UPDATE: The probate threshold in California has risen since the time of recording the embedded video from $166,250 to $184,500. The content of this article has been updated to reflect this change.
You've done the work to set up your living trust. You went to an attorney. You had it set up, and you've transferred your real property into the trust. What's next? The question we often hear at this point is, “What about my investment or retirement accounts? My brokerage, my 41k, my IRA? Do those go into my trust?”
Here, we’ll discuss what our clients should with their 401(k)s, IRAs and regular brokerage accounts when planning their estate. Part of our process is going through all of our client's assets with a fine-tooth comb to determine what assets should go into their revocable living trust and what assets can stay outside of their trust.
General Rule: Probate Threshold
The general rule we need to always keep in mind is the probate threshold. Here in California, that is a gross estate of $184,500 or more. If the value of your assets in your estate (not inside of a Trust) come together to equal $184,500 or more, then your estate must go through probate. One of the main purposes of creating a living trust is to avoid probate in the first place.
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Brokerage Accounts
Many of our clients have a brokerage investment account, maybe with Morgan Stanley or Vanguard for example, which simply holds many of their assets they've built up over time and that have been put to work in investments. The question we then must address is, “Should I put that brokerage account in my trust?” Always considering the general rule of voiding the probate threshold, we typically recommend putting that brokerage account in your trust, even if it alone won’t trigger a probate, due to two reasons.
Firstly, these types of account are often (or at least intended to be) of fairly substantial value when considering the probate threshold. Secondly, the idea is as long as it's being managed correctly, it's likely going to grow over time. Due to this, your brokerage account should almost always go inside your trust so it can grow as intended and never trigger a probate issue as it grows inside the Trust.
Retirement Accounts: 401(k)s and IRAs
This brings us to the other two accounts mentioned above – your retirement accounts, those being a 401(k) and an IRA. In either case, you have the ability to set beneficiaries on those accounts. The act of picking a beneficiary means the assets in those accounts become the property of that beneficiary(ies) at your passing. So long as beneficiaries are designed (and they outlive you), these funds will not count towards the probate threshold calculation for probate.
It is due to this that we often tell our clients to simply pick individuals as beneficiaries of your retirement accounts and not worry about the Trust in this case. The individuals then have the flexibility of going to collect their inheritances from the company directly, rather than having to go through the trust and the trustee.
Those beneficiaries will also have some flexibility as to how they wish to receive that inheritance (liquidate and cash out or roll over) so dealing with the company directly is often easier for them as well in this case. Just keep in mind, that if someone is a beneficiary of an IRA, they have to pull the money out within 10 an IRA, they have to pull the money out within 10 years if they elect not to pull money out right away.
Read more: Latest 2023 Adjustments for 401(k)s and IRAs | Save More for Retirement
Trust as Beneficiary – Qualified, Pass-Through and Conduit Trusts
However, this raises another question, “Can I pick my trust as a beneficiary?” Yes, your trust can be the designated beneficiary of an IRA or 401(k).
There are some considerations that you should keep in mind when determining whether or not you should have individuals as the beneficiaries versus the trust. There are a couple phrases or terms you should kind of keep in mind. It depends on the industry, but you will typically hear at least one of these three: qualified, pass-through or conduit.
By default, our trusts are all three of those, but what does that mean? It means, if there are going to be any taxes owed on assets in, for instance, an IRA or 401(k), then the trust allows for that tax burden to be passed through to the ultimate beneficiaries of the trust. Why would you want to do that? It is oftentimes more tax advantageous for the individual to pay the owed taxes than it is for a trust to pay any taxes. Trusts are taxed at a much higher rate than individuals so the overall tax burden will be lower for each beneficiary if they pay the taxes owed on their received portions of the funds.
Another point to keep in mind is that when you pick your trust as a beneficiary, you can always amend and change your trust during your lifetime so long as you have a revocable living trust. That means every time you change the distribution on your trust, you are ultimately changing the distribution of the IRA or 401(k) as well. This allows you to make those changes around the table with your attorney rather than going through the company holding those accounts and going through their forms.
Trust as a Safety Net
Going further, when our clients elect to pick individuals as beneficiaries of their accounts, we often counsel them to at least have the trust as a contingent beneficiary. Essentially, the trust creates a safety net under those assets to grab those assets and distribute according to your trust in the event your initial beneficiary(ies) predeceased you.
Keep in mind, however, even where the trust is a beneficiary of an IRA and the beneficiaries of the trust receive their inheritances, they are still required to take the money out within 10 years if they elect not to pull it out right away. Previously they could do so over their lifetime, but under the current laws, they can only keep the funds in that IRA for no more than 10 years.
Read more: Estate Planning Rundown for 2023: The Numbers You Need to Know
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