Recently, a colleague asked me about re-titling qualified and non-qualified accounts into a revocable trust. My reply after advising her that “my response is informal, general information…I do not know the specific details about your clients’ assets…you need to consult an attorney who can give you targeted advise before you move any assets…” was as follows:
Basically: Qualified plans allow employers to deduct an allowable portion of pretax wages from employees, the employee can exclude that contribution from their taxable income, and the contributions and the earnings then grow tax-deferred until withdrawal (generally at retirement). Non-qualified plans are not eligible for tax-deferral benefits, employers, and employees have to pay income tax on contributions from the employer when the benefit is given/received. I.e., the difference for employees refers to when the employee must pay income tax on benefits associated with their employment (whether when received or when withdrawn). There are a lot of other differences, mostly relevant for employers in meeting criteria for plan to be considered qualified so that they may deduct the benefit paid to employees.
Accounts: Qualified: IRAs (generally), 401(k) plans, 403(b) plans, and profit-sharing plans. Non-qualified: Brokerage accounts, individual stocks…other accounts that do not have a tax-deferral feature.
Why all the fuss? If you retitle the name of qualified retirement accounts (401(k)s, 403(b)s, IRAs and qualified annuities) into the name of a revocable living trust, the transfer will be treated as a complete withdrawal of the funds from the account and 100% of the value will be subject to income tax in the year of the transfer. This is a BIG problem. Generally, it is best to change the primary or secondary beneficiary of the account to the name of the trust, rather than re-titling the account.
That said, there are many ins and outs with respect to the best form of trust and options within the trust model for directing your retirement benefits during your life and after your passing. For clients with retirement account value that exceeds what they will need during life, it may be wise to explore the benefit of stretching distributions to maximize the tax-deferral feature of those funds for as long as possible. This topic is beyond the scope of this post, but worth a mention.