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By: Scott Grossman on February 26th, 2018

Know the Difference Between Conduit and Accumulation Trusts

First, Determine Whether the Trust Is a Designated Beneficiary:

To help people save for retirement, the government allows us to put money aside in tax-deferred accounts. When we reach a certain age, we must then begin taking distributions from these accounts. The longer we can wait before withdrawing the assets in a tax-deferred account, the more tax savings we will achieve. When a person dies without having fully depleted their retirement assets, it is not uncommon for complications to occur. This is why it is also equally important to also understand the difference between conduit and accumulation trusts.

To stretch out the required distributions of retirement assets, instead of taking the entire asset in one lump sum, the beneficiary of such an asset must qualify as a “designated beneficiary” as defined by the IRS. Trusts can, in some cases, qualify as designated beneficiaries. You must determine whether the trust is a designated beneficiary of the decedent’s retirement asset. This must be done before beginning the process of administration.

 The Trust Must Meet The Following Requirements:

  1. The trust must be valid under state law.
  2.  Trust must be irrevocable at the death of the owner of the retirement plan.
  3. The custodian of the retirement plan must have received the trust instrument.
  4. The beneficiaries of the trust must be identifiable from the trust instrument.

If the trust does not meet the above requirements, this significantly impacts how the retirement asset will be handled during administration. In some cases, the account needs to be entirely distributed within five years of the year in which the owner of the retirement plan died. This often results in significant financial losses due to taxes, in some instances as much as 40% of the account If the trust does meet the requirements for being a “designated beneficiary” under IRS rules, distributions of the retirement asset can be stretched out based on the beneficiary’s life expectancy, resulting in significant financial savings.

About Conduit and Accumulation Trusts:

To avoid the potential pitfalls associated with a trust being a beneficiary of a retirement account, your loved one may have used a conduit trust or an accumulation trust when creating his or her estate plan. Conduit and Accumulation trusts can be used to prevent the requirement that the account is drained within five years of the decedent’s passing. Meanwhile, it is important to understand their differences as they can significantly impact the administration process. After you establish that the trust is a “designated beneficiary” of the decedent’s retirement assets, it is important to know the difference between conduit and accumulation trusts.

What is a Conduit Trust? The following is an overview:

  1. A conduit trust has a single individual as a primary beneficiary.
  2. The trustee of a conduit trust must take at least the minimum required distribution from the retirement account each year.
  3. The trustee then passes the amount of the minimum required distribution directly to the trust’s beneficiary.
  4. The life expectancy of the trust’s primary beneficiary is used to stretch out the minimum required distributions. This is done, rather than using the life expectancy of the original owner.
  5. The remainder beneficiary can be anyone or anything. This means that the charity can be named as a remainder beneficiary of a conduit trust. This would not impact the trust’s qualification as a designated beneficiary.

Another type of trust often used to plan for retirement assets is an Accumulation Trust.

What is an Accumulation Trust? The following is an overview:

  1. The IRS essentially defines an accumulation trust as any type of trust that is not a conduit trust.
  2. The trustee does not have to immediately distribute withdrawals from the retirement account.
  3. The trustee may instead hold the withdrawals in trust.
  4. By holding the distributions in trust, or accumulating the distributions, the trust receives the benefit of asset protection and the ability to minimize taxes.
  5. The life expectancy of the oldest beneficiary is used to determine the minimum required distributions for all beneficiaries.
  6. Only one individual is allowed to be named a beneficiary, whether it be a primary or remainder beneficiary of a trust. This would not impact the trust’s ability to qualify as a designated beneficiary.

During the administration of a trust, trustees must be aware of various tax-related issues. This is especially true concerning retirement assets. Depending on who was the named beneficiary of the asset and how the trust was drafted, the account may need to be distributed quickly, or it may be stretched out over a longer period of time. Further, the distributions may potentially be held in the trust for a period of time, or it may be required that they be paid over directly to the beneficiary. Trustees need to understand what they are working with during a trust administration.

If you are ready to start your case, then please give us a call or fill out our Get Help Now form. A comprehensive overview of California Probate is available here. Should you have additional questions about trust litigation, you will find plenty of useful information in our Learning Center.