Can a 401(k) Be in a Trust?

A 401(k) is an employer-sponsored retirement savings plan that allows employees to save and invest for retirement on a tax-deferred basis. Contributions to a traditional 401(k) are typically made before federal income taxes are calculated, providing an immediate tax reduction. Earnings within the account can grow without being taxed until withdrawn in retirement, usually after age 59½ to avoid penalties. A trust is a legal arrangement where assets are held by one party, the trustee, for the benefit of another party, the beneficiary. This arrangement establishes a fiduciary relationship, with the trustee managing the assets according to the trust creator’s instructions. A common question arises regarding whether a 401(k) can be held within a trust, a topic involving nuanced estate planning considerations.

Understanding 401(k) Ownership

A 401(k) account is an individual account held within a qualified retirement plan. The plan itself is established under a trust agreement, as mandated by the Employee Retirement Income Security Act of 1974 (ERISA). This ensures the plan’s assets are held in trust, separate from the employer’s assets, for the exclusive benefit of all plan participants and their beneficiaries.

During a participant’s lifetime, the assets within their 401(k) are held in their individual name for their benefit, operating within this established plan trust. A 401(k) cannot be re-titled or transferred into a separate personal estate planning trust, such as a revocable living trust, while the participant is alive. Attempting such a transfer would be considered a taxable distribution of the funds. This action could trigger immediate income tax obligations on the entire amount transferred and may also incur a 10% early withdrawal penalty if the participant is under age 59½. Therefore, direct ownership of a 401(k) by a personal trust during the participant’s lifetime is not advisable due to these significant tax consequences.

Naming a Trust as a 401(k) Beneficiary

While a 401(k) cannot be owned by a personal trust during the participant’s lifetime, a trust can be designated as the beneficiary of the 401(k) account upon the participant’s death. Individuals often choose this option for various estate planning reasons instead of naming an individual directly. Naming a trust allows for greater control over the distribution of assets, which can be particularly beneficial for minor heirs, beneficiaries with special needs, or those who may not be capable of managing a significant inheritance responsibly. A trust can also protect inherited funds from a beneficiary’s creditors or ensure assets pass to specific heirs across generations, especially in cases of blended families.

When a trust is named as a 401(k) beneficiary, it is structured as either a “conduit trust” or an “accumulation trust”. A conduit trust requires that any distributions received from the 401(k) must be immediately passed through to the trust’s individual beneficiaries. This structure ensures that the distributions are taxed at the individual beneficiaries’ income tax rates, which are often lower than trust tax rates. In contrast, an accumulation trust provides the trustee with the discretion to either distribute the funds to the beneficiaries or retain them within the trust. This flexibility can offer enhanced asset protection for the funds held within the trust, but any income retained by the trust is taxed at higher trust income tax rates.

For a trust to be treated as a “look-through” or “see-through” trust by the IRS, allowing the trust’s beneficiaries to be considered for Required Minimum Distribution (RMD) purposes, it must meet specific requirements. These requirements include the trust being valid under state law and becoming irrevocable upon the death of the 401(k) owner. All beneficiaries of the trust must also be identifiable individuals. Proper documentation, such as a copy of the trust instrument, must be provided to the plan administrator by a specific deadline. Precise drafting of the trust document is essential to meet these IRS criteria and effectively implement the desired estate planning objectives.

Post-Death Distribution Rules for Trust Beneficiaries

The rules governing distributions from a 401(k) after the participant’s death, particularly when a trust is named as the beneficiary, were altered by the SECURE Act of 2019 and further refined by SECURE 2.0. For most non-spouse beneficiaries, the ability to “stretch” distributions over their lifetime was eliminated, replaced by a general 10-year rule. This rule mandates that the entire inherited account must be distributed by the end of the calendar year containing the 10th anniversary of the original account owner’s death.

The “look-through” trust status plays a role in how these RMD rules apply to the trust beneficiaries. While the 10-year rule applies broadly, certain “eligible designated beneficiaries” (EDBs) are exceptions. These EDBs may still be able to stretch distributions over their life expectancy, offering longer tax deferral.
EDBs include:

• Surviving spouses
• Minor children of the deceased account holder
• Disabled individuals
• Chronically ill individuals
• Individuals who are not more than 10 years younger than the deceased

The distinction between conduit and accumulation trusts impacts the timing and taxation of post-death distributions. For a conduit trust, any RMDs or other distributions paid from the 401(k) to the trust must be immediately distributed to the individual beneficiaries, who then pay the income tax at their personal rates. Conversely, an accumulation trust grants the trustee discretion to hold distributions within the trust, which can then be taxed at the trust’s higher income tax rates if the income is not distributed to the beneficiaries.