Naming an IRA as a Trust Beneficiary

When a trust is named as the beneficiary of an IRA (Individual Retirement Account), the trust is inherited by the account when the owner passes away. Naming an IRA as a beneficiary of a trust has significant estate planning, financial, and tax implications. Importantly, there are several key considerations to keep in mind when setting up a trust as the beneficiary of an IRA.

Qualified Trust Requirements

To ensure favorable tax treatment, the trust must be considered a "qualified trust" under IRS rules. This means the trust must meet specific requirements, such as being irrevocable upon the IRA owner's death and having identifiable beneficiaries. The trust must be valid under state law and become irrevocable upon the death of the IRA owner.

There are also requirements for the trust beneficiaries. All beneficiaries of the trust must be identifiable and meet certain criteria. In addition, the trust documents must be provided to the IRA custodian by October 31 of the year following the IRA owner’s death.

Types of Trusts for IRA Beneficiary Designation

There are two types of trusts that can come into play for the purpose of IRA beneficiary designations. The first type of trust is a conduit trust. Specifically, a conduit trust mandates that all required minimum distributions (RMDs) from the IRA are passed directly to the trust beneficiaries. This can simplify the process and maintain the stretch IRA benefits, allowing for distributions to be spread out over a longer period of time.

The second type of trust is called an accumulation trust. An accumulation trust allows the RMDs to be retained in the trust. This can provide more control over the distribution of assets. However, it is vital to note that this type of trust can result in higher taxes, as the trust may be subject to higher income tax rates compared with individuals.

Tax Implications of Naming a Trust as an IRA Beneficiary

It’s essential to consider the tax implications of naming a trust as an IRA beneficiary. If the trust is a designated beneficiary (meaning it qualifies under IRS rules), the RMDs are generally calculated based on the life expectancy of the oldest trust beneficiary.

However, if the trust does not meet the IRS criteria to be a designated beneficiary, the entire IRA must be distributed — and taxed — within five years if the account owner dies before age 72, or over the remaining life expectancy of the deceased owner if they die after age 72.

SECURE Act Considerations

The SECURE Act, passed in December 2019, changed the rules for inherited IRAs. Under this law, most non-spouse beneficiaries must withdraw all assets from an inherited IRA within 10 years. Trusts that were set up before the SECURE Act was enacted may need to be reviewed to ensure they still accomplish the desired objectives under the new law.

What are the Advantages of Naming a Trust as an IRA Beneficiary?

Naming a trust as an IRA beneficiary has several crucial advantages. For instance, it can determine a beneficiary’s access to the inherited assets, name successor beneficiaries, and provide solutions for those who are in second marriages by allowing them to provide for children from their first marriages. Some of the other benefits that come with naming a trust as an IRA beneficiary can include the following:

• Control over distribution — Naming a trust as an IRA beneficiary allows the IRA owner to control how and when the IRA assets are distributed to beneficiaries after their death.
• Protection from creditors — A trust can offer protection from creditors, ex-spouses, and other parties who might otherwise have a claim against the IRA assets.
• Special needs planning — A trust can be useful if a beneficiary has special needs or is a minor, ensuring that the funds are managed properly and do not interfere with eligibility for government benefits.

Additionally, if a beneficiary passes away before they have received their full share of the distribution, the trust can define what will happen to those shares.

What are the Disadvantages of Naming a Trust as an IRA Beneficiary?

There are a few drawbacks to keep in mind when it comes to naming a trust as an IRA beneficiary. Two of the biggest disadvantages are complexity and cost. Setting up a trust and ensuring it complies with IRS rules can be complicated and may require the assistance of an attorney or financial advisor, which can result in incurring additional expenses.

In addition, there is also the potential that you might incur a greater tax burden. Significantly, trusts are taxed at higher rates than individuals. In other words, if the IRA distributions are accumulated within the trust, it could result in higher taxes.

Contact a Knowledgeable Michigan Estate Planning Attorney

Designating a trust as the beneficiary of an IRA can be an effective estate planning strategy, but it requires careful consideration of the rules and potential tax implications. It's vital to work with a qualified estate planning attorney, accountant and financial advisor to ensure that the trust is structured correctly and aligns with your overall financial and estate planning goals. With offices in East Lansing, Mt. Pleasant, Grand Rapids, and Detroit, The Gallagher Law Firm offers a wide range of professional services for all your estate planning needs. To learn more about how we can assist you, contact us online, call (517) 853-1515 or email bpg@thegallagherlawfirm.com.