Should a 401(k) Be Put Into a Living Trust?

By Jeffry Olson, J.D.

Should a 401(k) Be Put Into a Living Trust?

By Jeffry Olson, J.D.

A grantor can transfer many types of assets into a living trust, but a 401(k) is not one of them. A living trust, which is a tool used in the estate planning process, allows its grantor (the trust's creator) to pass assets to beneficiaries without the need for probate.

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A living trust holds assets, names specific beneficiaries, spells out instructions regarding the distribution of assets, and appoints a trustee to manage the trust and oversee the handling and distribution of the assets. Individuals who wish to pass their assets to their beneficiaries often want to avoid probate because it can be a long, costly, and sometimes publicized\ process. But creating this during someone's lifetime to help avoid the complex probate process that might likely occur after someone passes away.

Limits of a Living Trust

Using a living trust as part of an estate plan does not automatically transfer assets into it. At the time of creation, the living trust is empty. The grantor can transfer assets, bank accounts, and real estate ownership into the trust. However, pursuant to federal law, you cannot transfer a 401(k) account to a living trust.

Living trusts can be either revocable or irrevocable. A revocable living trust allows the grantor to change their mind about the assets initially placed in the trust, along with the existence of the trust itself. If a grantor transfers assets to an irrevocable living trust, however, the trust owns those assets. Therefore, the grantor cannot retrieve them thereafter.

Ownership and Options of a 401(k) Account

If you change the ownership structure of your 401(k) account, the Internal Revenue Service (IRS) will treat this as an early withdrawal. As a result, the money taken out will be fully taxable in the year the transfer takes place. If you are under the age of 59½, you must pay a 10 percent penalty for the early withdrawal. This completely defeats the purpose of using this type of account as part of your retirement plan.

Instead of transferring funds in your retirement account to your living trust, consider changing the beneficiaries to align with your estate plan. If you're married, a spousal rollover is likely the best option. Make your spouse the first beneficiary. A retirement account can roll over to your spouse pursuant to special IRS rules. Your spouse can then roll it over to their heirs. This approach allows you to stretch out tax consequences for many years.

If you do not have a spouse, name a beneficiary consistent with your wishes and estate plan. At the time of your death, the funds in your account will then transfer to your beneficiaries without having to go through the probate process.

After creating a living trust, you must transfer assets into it as soon as possible. This includes real estate and bank accounts, but not your 401(k). Transferring funds to a living trust has immediate tax consequences. Instead, use the beneficiary designation for your retirement account to transfer the assets upon your death.

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