Should You Name A Trust As A Beneficiary Of Your IRA?

26 Jul Should You Name A Trust As A Beneficiary Of Your IRA?

After the passage of the Secure Act a few years ago, planning by naming a trust as a beneficiary of a retirement account (that is not a ROTH IRA) had to be reconsidered. Previously a designated beneficiary (even if the trust is named as the beneficiary and the trust is properly drafted as described below) could stretch distributions over the beneficiary’s life expectancy resulting in tax-deferred growth.

After the effective date of the Secure Act, a beneficiary of an IRA cannot stretch distributions more than 10 years unless the beneficiary (called “eligible designated beneficiary”) is (1) the surviving spouse; (2) within 10 years age difference of the IRA account owner; (3) a minor child (not grandchild) of the IRA account owner; (4) disabled; or (5) chronically ill. Otherwise, the longest period of stretch of distributions for a designated beneficiary is 10 years. Furthermore, if the beneficiary is a trust for the benefit of one or more beneficiaries named in the trust, the trust must be a “see-through” trust for the beneficiary to get the 10-year stretch.

For the trust to be a “see-through” trust it must be either a conduit trust (required minimum distributions must be passed through to the beneficiary or beneficiaries which will result in the beneficiary being taxed on the income distributed) or an accumulation trust (required minimum distributions stay inside the trust, but the trust is taxed at the trust tax rate – which presently is 37% on income that exceeds $15,200 in year 2024).

Additionally, the following must be met to be considered a see-through trust:

1. The trust must be valid under state law.
2. The trust must be irrevocable or become irrevocable upon the death of the account owner.
3. The beneficiaries must be readily identifiable – although it could be a class of beneficiaries (i.e., all to my children).
4. A copy of the trust must be given to the custodian by October 31 of the year after the IRA owner’s death.

If the trust isn’t a see-through trust, then distributions often must be taken within five years of the account owner’s death.

Common examples of when a trust is named as a beneficiary of an IRA:

1. Disabled beneficiary: If your beneficiary is disabled or could lose valuable public benefits such as Medicaid, then a special needs trust could be the beneficiary of the IRA. If the beneficiary is on Medicaid, then the trust should be an accumulation trust since income distributed as a conduit trust would jeopardize Medicaid due to income eligibility rules. A lifetime stretch is available (even though income could be held in the trust).
2. Minor child as a beneficiary: Whenever a child is an intended beneficiary, a trust should be considered as a minor is presumed to be unable to handle assets.
3. Surviving spouse as a beneficiary when you have children from a prior marriage: If you have children from a prior marriage and you want your spouse to get your required minimum distributions until the death of that surviving spouse before distribution to your children, then a trust should be considered for protection of your children. Otherwise, the surviving spouse (by inheriting outright) could do anything they want with the inherited IRA to the detriment of your children. Some also consider this if they are concerned their spouse may remarry.
4. Reducing risk that son-in-law or daughter-in-law or others receive if your beneficiary who is your child survives you but passes away prior to their spouse: As a result of the Secure Act, this has less protection than previously due to the requirement distributions be made within 10 years following the year of death (even if it is a see-through trust). If you just named your child as an outright beneficiary, then they may name their spouse, who may remarry, as a beneficiary which could be to the detriment of your grandchildren.
5. Concern that beneficiary won’t stretch to the advantage of tax-deferred growth: Most beneficiaries of an IRA withdraw the IRA immediately resulting in accelerated income taxation instead of taking advantage of tax-deferred growth. Thus, some IRA owners use a trust to force tax-deferred growth (distributions determined by law if the IRA owner had already reached the age for required minimum distributions).
6. Beneficiary has an addiction or there could be estrangement: An accumulation see-through trust could be used with various incentives to make sure the funds are not used for the addiction. Incentives could be used to encourage treatment or recovery. Control over future estrangement is sometimes also an issue.
7. Creditor protection if accumulation trust: If the beneficiary has creditor issues, the RMDs could be subjected to the creditors of the beneficiary. If the distributions are held inside the trust (which would be the case if it is an accumulation trust), then distributions are protected since the trust is irrevocable. Furthermore, in most states (unlike Texas), an inherited IRA is not protected from creditors.
   
   

Why you shouldn’t name a trust as a beneficiary:

1. Even if the trust is a see-through for a designated beneficiary, the stretch is limited to 10 years: Since the government wants its tax dollars quicker as a result of the passage of the Secure Act, there is less tax benefit.
2. Income Taxation vs. Creditor Protection: If the trust is an accumulation trust, then there is a higher income tax rate (37% on income over $15,200 in year 2024 if held in an irrevocable trust). If the trust is designed as a conduit trust, the income distributions could be subjected to the creditors of the beneficiary. As a result, what is the goal – less income tax or creditor protection?
3. Trust not drafted as a see-through trust: If the trust doesn’t meet the requirements of a see-through trust, then the tax advantages of tax-deferred growth would be lost.
4. Administrative Cost: There could be additional administrative costs to be sure the terms of the trust and law are followed.
5. Custodian doesn’t want to fight the IRS: The IRS may take the position that since an individual is not named, then there should be immediate taxation (or at least within five years) since a trust has no life expectancy. The trust must be a see-through trust and meet the four requirements set forth above to get the stretch. Custodians (such as a bank or brokerage firm) may not want to fight the IRS and just pay the tax.
   
   

In deciding whether to name a trust as a beneficiary, control over distributions must be weighed against income tax issues, IRS reporting and administrative costs or possible future law changes.

If interested in learning more about this article or other estate planning, Medicaid and public benefits planning, probate, etc., attend one of our free upcoming Estate Planning Essentials workshops by clicking here or calling 214-720-0102. We make it simple to attend and it is without obligation.