A new client, a tech executive from Manhattan, recently sat in my office with a freshly signed revocable living trust. He was proud of the work he’d done to protect his family. His next question was a common one: “So now I just call my broker and have him move my 401(k) and my IRA into the trust, right?”
My answer was, “Not so fast.”
A trust is a powerful tool for generational stewardship. It allows you to direct your assets, avoid the public process of Surrogate’s Court, and provide for your family with precision. But a trust is not a universal filing cabinet for every financial instrument you own. The act of “funding” a trust—transferring assets into its name—must be deliberate. Placing the wrong asset in a trust can create the very tax burdens and legal tangles you were trying to avoid.
Retirement Accounts Operate Under Different Rules
The most common assets we advise clients to keep out of their trusts are tax-deferred retirement accounts, such as IRAs, 401(k)s, 403(b)s, and similar plans. This is not because a state law forbids it, but because federal tax law governs these accounts. Their primary benefit is tax-deferred growth, and disrupting that status has significant consequences.
When you transfer ownership of a typical asset like a brokerage account to your revocable trust, you have not triggered a tax event. You still control the asset. But moving an IRA or 401(k) into a trust is treated by the IRS as a full distribution of the account. This means the entire value could become taxable income in that single year, potentially pushing you into a higher tax bracket and erasing decades of tax-deferred growth.
Instead of transferring ownership, the prudent strategy is to coordinate the account’s beneficiary designation with your estate plan. You can name individuals directly or, in specific situations, name the trust as a beneficiary. This requires careful drafting. For a trust to properly receive retirement assets without immediate tax consequences for its beneficiaries, it must meet strict IRS criteria to be considered a “see-through” or “conduit” trust. If not drafted correctly, the trust could be forced to withdraw the entire inherited IRA within a few years, accelerating the tax burden for your heirs.
Your Primary Residence and Key Tax Exclusions
For many families, their home is their most significant asset. It seems logical to place it in a trust to avoid probate. For a standard revocable living trust, this is often the right move. As the grantor, you retain full control and, critically, you preserve the capital gains tax exclusion under Section 121 of the Internal Revenue Code. This allows a qualifying individual to exclude up to $250,000 (or $500,000 for a married couple) in capital gains from the sale of their primary residence.
The problems arise with certain types of irrevocable trusts, often used for asset protection or Medicaid planning. Transferring your home to an irrevocable trust means you relinquish control. Depending on how that trust is structured, you may forfeit the ability to claim that capital gains exclusion. If your children—as trustees—later sell the home, they could face a substantial tax bill that would not have existed otherwise.
We also advise caution with smaller personal assets. While you can legally title your daily-use vehicle to a trust, the process at the DMV can be cumbersome. New York law offers simplified procedures for transferring motor vehicles upon death, and for many, the administrative effort of retitling the car outweighs the probate benefit.
Assets That Already Avoid Probate
A primary goal of a living trust is avoiding probate. Many assets, however, are already designed to do this through their own beneficiary designations. These include:
- Life Insurance Policies: The death benefit is paid directly to the named beneficiary, a contractual process that happens outside of court.
- Annuities: Like life insurance, annuities pass directly to the designated beneficiary upon the owner’s death.
- Payable-on-Death (POD) Bank Accounts: These are standard bank accounts with a form on file naming who should receive the funds upon your death.
- Transfer-on-Death (TOD) Brokerage Accounts: This is the equivalent of a POD account for stocks, bonds, and other securities.
Funding a trust with these assets by changing their ownership is redundant. The prudent approach is to review your beneficiary designations, confirming they are current and align with the overall goals of your trust. For instance, you might name your spouse as the primary beneficiary and your trust as the contingent beneficiary. This ensures the asset avoids probate and is managed according to your wishes if your primary beneficiary is unable to inherit.
The legal framework for creating and funding a trust is established in New York’s Estates, Powers and Trusts Law. EPTL §7-1.18, for example, provides a method for a grantor to certify a trust’s key provisions without having to disclose the entire document. But knowing the law is only half the battle. The other half is applying it with prudence and foresight.
An effective estate plan is not built by putting every asset into one bucket. It is built by making deliberate, intentional choices about how each asset should be managed and passed to the next generation.
The first step in this process is often an audit of your existing asset titles and beneficiary designations. If you are concerned about how your assets are structured, we can schedule a meeting to review them against your family’s long-term legacy goals.
