Spouse or Trust as Beneficiary of Your Retirement Accounts

When it comes to planning your financial legacy, few decisions are as impactful as choosing the beneficiaries for your retirement accounts—such as IRAs, 401(k)s, or 403(b)s. These accounts often hold the fruits of decades of hard work, and how you direct them after your passing can shape your loved ones’ financial futures. Two popular options stand out: naming your spouse directly as the beneficiary or designating a trust created for their benefit. Each path offers distinct advantages and challenges, influencing everything from taxes to control over the funds.

In this article, we’ll examine these choices step by step. We’ll start with the basics of retirement accounts and beneficiary designations, then explore Required Minimum Distributions (RMDs), and finally compare the spouse-versus-trust decision in depth, complete with examples to bring the concepts to life.

Retirement Accounts and Beneficiary Designations

Retirement accounts are specialized savings tools designed to help you prepare for life after work. Common examples include Individual Retirement Accounts (IRAs), 401(k)s offered by employers, and 403(b)s for certain nonprofit workers. These accounts enjoy tax benefits—either tax-deferred growth for traditional versions or tax-free withdrawals for Roth versions—but they come with rules about how and when the money can be accessed.

A beneficiary designation is your way of telling the account custodian (like a bank or investment firm) who should inherit the funds when you’re gone. This instruction is powerful, and it takes precedence over your Will, often making it a cornerstone of your estate plan. You might name your spouse, a trust, your children, or even a charity, but your choice carries significant consequences for taxes, distribution timing, and asset protection.

Required Minimum Distributions (RMDs)

To understand how your beneficiary choice plays out, you need to grasp Required Minimum Distributions (RMDs). These are mandatory withdrawals the IRS requires from most retirement accounts. For traditional accounts, RMDs begin at age 73 for those born in 1951 or later, age 75 for those born in 1960 or later, or age 70½ for those born before July 1, 1949.

The idea is simple. The government wants to collect taxes on the money you’ve sheltered from taxes over the years.

How RMDs Work: Each year, you withdraw an amount based on your account balance (as of December 31 of the prior year) divided by a life expectancy factor from IRS tables. The first withdrawal is due by April 1 of the year after you turn 73 (your Required Beginning Date, or RBD), with subsequent withdrawals due by December 31 annually.
The Penalty: Miss an RMD, and you’ll owe a hefty tax on the amount you should’ve taken out.

After your death, RMD rules shift depending on who inherits the account (whether your spouse, a trust, or someone else). This is where your beneficiary decision starts to matter.

Option 1: Naming Your Spouse as the Beneficiary

Naming your spouse directly is a common and straightforward choice. It offers unique perks, especially when it comes to taxes and flexibility. For these reasons, naming the spouse is typically the more popular option.

Advantages of Naming Your Spouse

Let’s review some of the advantages of naming your spouse:

The Rollover Advantage: Your spouse can transfer the inherited account into their own IRA (a process called a spousal rollover). Once it’s theirs, they treat it as their own, meaning no RMDs until they hit 73. If they’re younger than you, this could delay withdrawals for years, letting the money grow tax-deferred (or tax-free for Roth IRAs).
Flexible Distribution Options: If they don’t roll it over, they can keep it as an inherited IRA. Here, RMDs depend on when you passed away:
- Before Your RBD: They can delay RMDs until the later of the year you would’ve turned 73 or the year after your death.
- On or After Your RBD: RMDs start the year after your death, based on their life expectancy.
Tax Benefits: Delaying withdrawals keeps more money growing tax-free or tax-deferred. When they do withdraw, it’s taxed as ordinary income (except for Roth IRAs, which are tax-free), but they decide the timing.

Downsides to Consider

Here are some of the key downsides:

No Control After Transfer: Once the funds are in your spouse’s account, they can spend, gift, or redirect them as they see fit. This could be a concern if you have kids from a prior marriage or specific wishes for the funds.
Vulnerability: The money could be at risk from creditors, lawsuits, or even a new spouse if they remarry (a prenuptial agreement with the new spouse may be helpful in this regard to address this concern).

This option shines for its simplicity and tax perks, but leaves you with little say over the funds’ future.

Option 2: Naming a Trust as the Beneficiary

Alternatively, you can name a trust as the beneficiary, with your spouse as the trust’s beneficiary. This approach trades some tax flexibility for greater oversight and protection.

What are the Advantages of Using a Trust

What are the advantages of the trust?

Customized Control: You write the trust’s rules, deciding how much your spouse gets and when. For instance, you could provide income for their lifetime while ensuring the remainder goes to your children or another heir.
Asset Protection: A well-drafted trust can help safeguard the funds from creditors, legal claims, or a new spouse if your partner remarries.

Challenges to Watch For

What are the drawbacks?

No Rollover Allowed: A trust can’t roll the account into your spouse’s IRA, so RMDs start the year after your death, based on your spouse’s life expectancy (assuming it’s a “see-through” trust that meets IRS rules).
Faster Withdrawals: Without the rollover delay, the account starts shrinking sooner, reducing tax-deferred growth.
Tax Trade-Offs: If the trust pays out RMDs to your spouse, they’re taxed at your spouse’s rate. But if the trust holds onto the money (an accumulation trust), it pays taxes at trust rates, which are often higher.

Therefore, naming your spouse directly usually extends tax benefits further, while a trust accelerates withdrawals (and increases taxes).

Taxes: Breaking Down the Differences

Taxes often tip the scales when trying decide whether to name the spouse directly on a retirement account or the trust. So let’s compare how each option plays out.

For Traditional Accounts (IRA, 401(k), 403(b))

Comparing the spouse vs. the trust, we see the following differences.

Spouse Directly:

Rollover delays RMDs to 73, maximizing tax deferral.
Withdrawals are taxed as ordinary income at your spouse’s rate.

Trust:

RMDs begin the year after the account holder’s death, shrinking the tax-deferred window.
Taxes depend on whether the trust distributes (spouse’s rate) or retains (trust’s rate) the funds.

For Roth IRAs

Even with a Roth IRA, we still have an issue because the RMDs start sooner.

Spouse Directly

If the spouse rolls over the IRA, no RMDs are required during your spouse’s life, and tax-free growth continues indefinitely (note that if kept as an inherited IRA, then the RMDs apply). Alternatively, a surviving spouse may choose to keep a Roth IRA as an inherited account instead of rolling it into their own IRA. For example, if the spouse is under age 59½ and may need to access the funds, keeping it inherited allows penalty-free withdrawals of earnings (something a rollover wouldn’t permit).

Trust:

RMDs are required based on your spouse’s life expectancy, but they’re tax-free. Still, this forces withdrawals sooner than a rollover would.

Therefore, naming your spouse directly usually extends tax benefits further, while a trust accelerates withdrawals (and increases taxes).

Control and Protection: The Trust Advantage

Tax perks aside, a trust has its own appeal when control and security are the greater priority:

Preserving Your Legacy: You can ensure your spouse benefits during their lifetime while directing leftover funds to kids, grandkids, or a cause you care about.
Guiding the Money: If your spouse isn’t great with finances, a trust can distribute funds responsibly via a trustee.
Shielding the Assets: It can help protect trust funds against creditors or a remarriage that might otherwise divert the money.

These strengths come with a cost in earlier RMDs and added complexity. For many, the trade-off in higher taxes is not worth it.

Scenarios: Seeing the Options in Action

Let’s explore two real-life examples to clarify the stakes.

Scenario 1: Maximizing Growth

Let’s look at the following example.

Setup: You die at 68, leaving a $500,000 IRA to your 63-year-old spouse.
Spouse Directly: They roll it into their IRA, delaying RMDs until 73 (10 years of tax-deferred growth).
Trust: RMDs start at 64, based on their life expectancy, but money is withdrawn (and taxed) sooner.
Outcome: The spouse-direct route keeps more money growing longer. The trust shrinks the account faster.

Scenario 2: Protecting Your Kids

Let’s focus on asset protection in this example when that is the greater priority.

Setup: You have two kids from a prior marriage and a $1 million 401(k). You die at 75.
Spouse Directly: Your spouse rolls it over, but later remarries and names their new partner as beneficiary, leaving your kids out.
Trust: The trust provides your spouse with income for life and then passes the rest to your kids as you intended.
Outcome: The trust ensures your wishes are followed, while the direct route risks your kids losing out.

Which Path Is Right for You?

Your choice hinges on what matters most:

Go with the Spouse Directly If:

Tax deferral and simplicity top your list.
You’re confident your spouse will handle the money wisely.

Opt for the Trust If:

You want to dictate how the funds are used or protect them for others.
You’re okay with earlier withdrawals and the loss of tax efficiency for that control.

Conclusion

Your retirement accounts are more than just savings. Naming your spouse directly keeps things simple and tax-friendly, while a trust offers control and protection at the expense of faster withdrawals. Both paths have merit, but the best one depends on your goals. Take the time to weigh your options. With thoughtful planning, you can ensure your hard-earned money supports your loved ones, just as you envision.