Everyone dreams of retirement, especially those who hope to retire early. Unfortunately, few of us make financial plans for retirement. The typical American family only has about $5,000 in retirement savings. Some Americans are fortunate enough to have a pension or an employer-sponsored 401(k) plan or smart enough to set up their own individual retirement account (IRA). For them, the concern is less about saving for retirement and more about how to manage retirement savings as part of an estate.
Types of retirement accounts
Retirement accounts broadly come in two categories: employee-sponsored plans and individual retirement accounts.
Employer-sponsored plans include:
- 401(k) – Employer-sponsored 401(k) plans allows employees to invest a portion of their paycheck before taxes are deducted.
- Pension – These increasingly uncommon retirement plans provide a fixed monthly payment to employees upon retirement.
- 403(b) – Also known as tax-sheltered annuities, 403(b) plans are exclusive to public school teachers, employees of tax-exempt organizations, and hospital administrators. These plans are similar to 401(k) plans because they allow employees to defer income toward the plan.
IRAs are provided by financial institutions and provide retirement savings solutions for Americans. IRAs are available in two forms:
- Traditional – These accounts allow investors to direct pretax income toward investments. The investment grows tax-deferred, with capital gains and dividends taxed on withdrawal.
- Roth – These accounts are funded with post-tax income. Withdrawals are not taxed unless they occur prior to the age of 59 and a half.
Retirement accounts and estate planning
The different types of retirement accounts are relatively easy to understand, but certain accounts require careful planning for your estate. The Employee Retirement Income Security Act (ERISA) protects retirement plans and funds from bankruptcy and creditor claims. However, the Supreme Court ruled in Clark v. Rameker that ERISA does not protect inherited IRAs from claims. Inherited funds are not considered retirement funds and are available to satisfy creditors if a beneficiary of an IRA files for bankruptcy.
There are, however, certain planning steps you can take to protect your beneficiaries. The most comprehensive of these options is a standalone retirement trust. These trusts are created solely to accept retirement assets, qualify as “see-through” trusts, and offer more protection against creditors. If you have retirement accounts, review any beneficiary designations and discuss the benefits of standalone retirement trusts.