If tax-deferred retirement plans (like IRAs, 401(k) or 403(b) accounts, Keogh Plans, to name a few examples) make up a significant portion of your estate, you may be confused about how that affects your estate planning. Major planning concerns include the estate tax treatment of accounts and how to defer income taxation for as long as possible.

The entire value of your IRAs and "qualified plans" (which term generally includes all the other tax-deferred retirement accounts) is includible in your estate for purposes of calculating your estate tax. That is true even though the plans may name a qualified beneficiary, and even though they are not subject to the probate process on your death. Most people will not have any estate tax liability on their death related to retirement accounts, however, for two reasons: the estate tax only applies to people who die with total assets greater than $1.5 million ($2 million, starting January 1, 2006), and anything left to a spouse escapes estate taxation anyway.

Still, couples worth more than the exemption equivalent amount (that $2 million figure, as of next year) may want to plan to preserve each spouse’s exemption for estate taxes. The most common method of doing that is for the first spouse to leave an appropriate portion of her or his estate in a "credit shelter" trust (sometimes called "exemption equivalent," "bypass" or simply "B" trust). If assets outside of retirement accounts are insufficient to adequately fund the credit shelter trust, it may be necessary to name the trust as beneficiary of some or all of the retirement funds. Even when it is not necessary, individual circumstances (like an incapacitated or spendthrift spouse, for example) may make it desirable.

The related problem facing parents with substantial retirement assets is how to encourage—or even require—children to cash in inherited retirement accounts as slowly as possible. If the child is beneficiary of a qualified plan or IRA, and chooses distributions over the longest possible period, the income tax effect can be minimized and the earnings on the remaining principal of the account maximized.

Unfortunately, many parents (and particularly those with larger retirement accounts) are uncomfortable leaving that choice to their children. Once again, an appropriate trust may be the best choice to be named as beneficiary (or contingent beneficiary, after a spouse) in some cases.

Naming a trust as beneficiary of your retirement account is easier than it once was, but still not so simple that it should be undertaken lightly. Beneficiary designations can be complicated and confusing, and you should discuss the choices—and your specific facts and needs—with both your financial planner and your estate planning attorney.

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