Tax-deferred retirement accounts, whether set up by an individual (such as an IRA) or through an employer (such as a 401-k or 403-b) are a way of deferring income taxes on income you earn this year, so you can save it, and invest it, and when you retire, take the funds out at what hopefully will be a lower income tax rate after you retire.

These funds have not been subject to income tax by the Federal government when paid to you, but the Federal government wants its income tax. All these retirement accounts do is postpone the year of collection. Not only the amount you contribute, but any interest, dividends or capital gains the funds have earned over the years they sit in the account have not ever been taxed either. Therefore you will own income tax on the entire amount you receive. (It should be noted that, although long-term capital gains have traditionally been taxed at a lower rate than ordinary income, the long-term capital gains included in such a retirement account are taxed at ordinary income rates.)

Retirement accounts all have the feature that you can name a secondary beneficiary. If you name an individual as the beneficiary, the asset does not go through the Probate Court system. If you name your estate as the beneficiary, then that assets does through the Probate Court system, which can lead to some undesirable results which are covered below. You can also name a trust as the recipient, and that too can lead to some undesirable results but, under certain family circumstances, may make sense.

If you take the easiest route and name a beneficiary or beneficiaries, they can be successive, such as “to my spouse if he/she survives me, and if not, to my children, Amy, Beth and Charlie in equal shares.” Upon your death, the options given a spouse are considerably more liberal than the options given a non-spouse beneficiary, but both can spread the withdrawal of the funds over a long period of time, or over a short period of time, as they may desire. So the spendthrift child could take his own share, in its entirety, and lose it all in a trip to Las Vegas, while the prudent child could take a minimum distribution each year and spread it out over a number of years.

If the retirement assets are left to your estate, the time period within which the executor must make decisions in order to avoid the typically unwanted consequence of the entire value of the retirement account being distributed in one year (and therefore in our graduated income tax system resulting in a higher percentage of it going to income tax than were it spread out over a number of years) can be greatly hampered by the current delays inherent in the New Hampshire Circuit Court system, partially due to the laws governing the probate of estates and partially due to the underfunding of the Courts and their lack of staff and responsiveness.

To a lesser extent, if a trust is made the beneficiary, although the adverse consequences of the trust having to take the entire distribution of the retirement account in one year can be avoided, this requires nimble and expert footwork by the trustee to ensure that this does not happen, as well as careful drafting of the trust to be sure the identity of the beneficiaries of the retirement account is made clear in the body of the trust. Therefore, one of the few circumstances where we would recommend that a trust be made the beneficiary of a retirement account is when the beneficiary is disabled or has special needs, and the trust for the beneficiary has been established as an irrevocable special needs trust for a single identified person, or when the person to whom the funds would go is a minor.