The content in this article was originally presented via a Lathrop GPM webinar. You can access the recording here.
Retirement accounts are often the largest financial asset clients hold, yet they are frequently overlooked in estate and investment planning. As these accounts grow and diversify, so do the risks of missteps that can trigger significant tax consequences. This overview outlines how to preserve tax advantages, avoid prohibited transactions and use retirement accounts strategically for wealth transfer and charitable giving.
Retirement Accounts Are a Cornerstone of Wealth
Retirement accounts—including 401(k)s, IRAs and HSAs—can represent more than half of the net worth of high-net-worth individuals. Even for clients with broader portfolios, these accounts are a critical part of long-term financial planning. Their tax-advantaged status makes them powerful tools for accumulating wealth, but also introduces complex rules that must be followed to avoid penalties.
Investment Flexibility Comes with Legal Limits
While 401(k)s are generally limited to employer-selected mutual funds and ETFs, IRAs offer greater investment flexibility. Clients often ask whether IRAs can invest in vacation homes, family startups or private equity. The answer depends on the nature of the investment and the parties involved.
Congress has allowed retirement accounts to grow tax-deferred or tax-free, but in exchange has imposed strict limitations. IRAs, for example, cannot invest in collectibles such as art or wine, and cannot transact with “disqualified persons,” a category that includes the account holder’s spouse, children, parents and entities they control. Violating these rules can result in the entire account being treated as distributed, triggering immediate taxation in pre-tax accounts and loss of future tax benefits.
Prohibited Transactions: Common Pitfalls
Prohibited transactions include purchases, sales, loans and services involving disqualified persons. Even indirect benefits, such as moving an IRA to a bank to receive a mortgage discount, can violate the rules. While some exemptions exist, they come with strict conditions and should be reviewed with legal counsel.
Estate Planning: Retirement Accounts Play by Different Rules
Retirement accounts pass by beneficiary designation and cannot be retitled into revocable trusts. This makes it essential to align beneficiary choices with estate planning goals. These accounts can be included in the gross estate for federal estate tax purposes and may be subject to state-level estate or inheritance taxes.
The SECURE Act significantly changed the rules for inherited IRAs. Most non-spouse beneficiaries must now deplete the account within 10 years. If the original account holder was taking required minimum distributions (RMDs), the beneficiary must continue those distributions annually. Spouses and minor children (until age 21) are among the few exceptions who can still stretch distributions over their lifetimes.
Naming a trust as a beneficiary can offer planning flexibility, especially for minor children or beneficiaries with special needs. However, the trust must include specific provisions to qualify for favorable tax treatment. Without careful drafting, the trust may trigger accelerated taxation under the 10-year rule.
Charitable Giving: A Strategic Use of Retirement Assets
Retirement accounts can be highly effective vehicles for charitable giving. Qualified charitable distributions (QCDs) allow account holders to donate directly to public charities, bypassing income tax on the distribution. While donor-advised funds and private foundations are excluded from QCDs, they can be named as beneficiaries of retirement accounts.
Clients may also consider naming a charitable remainder trust (CRT) as the beneficiary. This allows a non-charitable beneficiary, such as a child, to receive income over a term of years, with the remainder going to charity. While distributions from the CRT are taxable, this strategy can help spread out the tax impact and fulfill philanthropic goals.
What You May Need to Do
Clients with significant retirement assets should take the following steps:
- Review investment holdings in IRAs to ensure compliance with prohibited transaction rules.
- Coordinate family investments to avoid triggering disqualified person status.
- Revisit beneficiary designations to align with estate planning goals and recent changes under the SECURE Act.
- Consider charitable strategies such as QCDs or CRTs to maximize tax efficiency.
- Consult with legal and financial advisors before making changes to retirement account structures or investments.
What This May Mean for You
Retirement accounts are more than just savings vehicles. They are strategic assets that require careful planning. Whether you are looking to invest in alternative assets, support family ventures or leave a charitable legacy, understanding the legal and tax frameworks is essential.
For questions about the tax and estate planning considerations related to retirement accounts and alternative investments, please contact Allie Itami or Sara Hire, or your regular Lathrop GPM attorney.