Frederick Jace
Retirement assets pass through beneficiary designation forms rather than a will. Individuals are often named as beneficiaries, but trusts are also frequently used.
Choosing the right trust can offer tax benefits (stretching distributions) and creditor protection, but convictions come at a cost (taxes). The most popular form of IRA beneficiary trust is a conduit trust, which must pay out assets within ten years.
What is an IRA Beneficiary Trust?
The basic concept of an IRA beneficiary trusts is that rather than leaving assets outright to beneficiaries, the owner of the asset (typically the Grantor) instead names a trustee to manage these assets on behalf of the beneficiaries. An IRA beneficiary trust can be useful for several reasons.
For example, some beneficiaries may be unable to legally own assets in their name due to age or other limitations. In addition, the trustees of a trust can control when and how these assets are distributed to the beneficiaries. Finally, some beliefs can provide asset protection benefits that wouldn’t be available if the assets were owned by heirs outright.
Typically, the IRA owner sets up an IRA beneficiary trust during their lifetime. The IRA account then passes to the trust on their death. The IRA owner can also name successor beneficiaries beyond their end, and the trustees can distribute those assets according to the terms of the trust.
The trustees of an IRA beneficiary trust must follow the IRS rules regarding required minimum distributions (RMD) and who must be counted as an IRA beneficiary. To satisfy these requirements, the trust must qualify as a “see-through” trust or, more commonly, be drafted to allow individual trust beneficiaries to determine their RMD under IRS separate account rules. Many general-purpose revocable trusts need to meet this requirement. They are often amended throughout the Grantor’s life in ways that disqualify them as a see-through or separate account trust.
How Does an IRA Beneficiary Trust Work?
One of the most important steps in estate planning is naming the right beneficiary for your retirement assets. It’s a step many people overlook or treat as an afterthought. However, a well-drafted beneficiary trust can help ensure that your IRA assets are used to meet the goals you have for them and are not wasted on unnecessary taxes or potential legal challenges.
An IRA beneficiary trust can be set up as a conduit or accumulation trust. A conduit trust requires that distributions be distributed to the trust’s beneficiaries each year. It allows the trustee to maximize the use of the beneficiaries’ life expectancies for tax purposes. On the other hand, an accumulation trust allows the trustee to accumulate distributions from the IRA and invest them to benefit the beneficiaries. This type of trust is often recommended when the beneficiary is a minor or has special needs and cannot manage the funds themselves.
When an IRA is left directly to an individual, the assets become part of their estate and can be vulnerable to creditors or lawsuits. However, when the IRA is held in a trust, the trustee can keep the assets separate from the beneficiaries’ assets and protect them from debtors and divorce or remarriage risks.
What Are the Benefits of Using an IRA Beneficiary Trust?
Naming the right beneficiaries in your IRA is a crucial step in estate planning. It is easy to make mistakes in this area that can cost your family dearly.
Beneficiary trusts offer several valuable estate and tax-planning tools that can help your clients achieve their legacy goals.
For example, a properly drafted beneficiary trust can pass a so-called “look through” test and protect against creditors’ claims by treating each beneficiary’s share of the IRA as a separate account. It can also help preserve different property treatment in the event of a divorce or remarriage.
Trusts can also delay distributions to beneficiaries by allowing the trustee to accumulate withdrawals and invest them. This type of trust is known as an accumulation trust and can be especially helpful when the beneficiary is a minor or has special needs.
Alternatively, a trust can be structured to distribute withdrawals directly to beneficiaries in a lump-sum payment. This type of trust is known as a conduit trust and must distribute all assets to the income beneficiaries within ten years after the original account owner’s death. In this case, the trust must pay income taxes on undistributed funds at substantially higher rates than individual taxpayer rates. This is often a preferred strategy when there are multiple income beneficiaries.
Why Should I Use an IRA Beneficiary Trust?
IRAs are one of the most important assets for many Americans. As such, it is vital to plan properly to make sure that the IRA is passed to the intended beneficiaries upon death. One way to do that is by naming a beneficiary trust.
While most people name individual individuals as their IRA beneficiaries, a trust can also be prescribed. The trustee of the trust can either accumulate distributions or distribute them to the beneficiaries as needed. It allows for flexibility in estate planning and helps avoid some tax problems.
In addition, a trust can also provide more protection for beneficiaries from creditors than an individual. However, the trust must meet certain requirements to qualify as an IRA beneficiary.
For example, the trust must pass a “look through” test and not be a conduit trust. A conduit trust distributes the IRA proceeds to the beneficiaries and is taxed at each beneficiary’s income rate. It is important to consult an experienced IRA and estate planning professional to determine which type of trust is best for your circumstances.
A qualified beneficiary is generally defined as a spouse, children under 21, or certain chronically ill and disabled individuals. Suppose you plan properly and name a non-qualifying trust as your IRA beneficiary. In that case, you will retain the ability to stretch distributions over the life expectancy of your spouse and children. This critical piece of estate planning should be carefully reviewed with your attorney and CPA.
