You can protect your IRA and 401k for your children.
When your children inherit your IRA or 401k, the retirement plan can continue to grow tax free and benefit from compounding interest – what Einstein, according to urban myth, called the most powerful force in the universe.
If your children are over 18, they will control their inherited retirement plan. What if they do what most people do and liquidate the retirement plan to pay bills, buy a car or make some silly purchase? The entire amount will be taxed to them as ordinary income and they will lose the huge benefit of tax free growth.
Can you protect against your children’s bad decisions?
Yes. Consider using a stand alone retirement plan. A stand alone retirement plan will name someone other than your child, like a brother or sister or close friend, to be trustee. The trustee will control the retirement plan distributions. She will have to distribute the required minimum distribution (the annual distribution the IRA requires based on your child’s age), but nothing else. The trust can be written to allow your child to take over as his or her own trustee at a certain age, presumably at an age when wisdom trumps impulse.
One of my clients recently came to us with two big concerns. She wanted to leave her IRA to her son and daughter, but she was afraid her son would blow his share, and she was afraid her daughter, who has a very rocky marriage, would allow her husband to talk her into liquidating her share. She didn’t want her children to control the IRA until they were 50.
We created a stand alone retirement plan trust to be the beneficiary of her IRA. We wrote the trust so that when our client dies, the IRA will be divided into separate trusts, one for her son and one for her daughter. Her brother will be the trustee of each trust. As trustee, he will control the distributions. He alone will decide whether to distribute more than the required minimum distribution. We included a provision to allow the trustee to make additional distributions if there was a compelling need, like to pay for medical expenses.
With her brother, not her children, in control, our client was confident the IRA would grow and not be wasted.
A stand alone retirement plan may be a good choice for you if you have a good size IRA or 401k, and you want to protect it for your children from bad spending decisions or from a bad marriage.