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A Trust as An IRA Beneficiary?

By: Investor Solutions

By: Investor Solutions

Not so long ago I got a call from one of my favorite clients. He is in the process of getting his financial affairs in order and wanted to know if he should name his family trust as the beneficiary of his IRA. After weighing the options, I advised him that unless there are compelling reasons to the contrary, it is usually best to leave retirement benefits outright to beneficiaries rather than placing them in trust.

When an Individual Retirement Account (IRA) is left to an individual beneficiary, that beneficiary can establish an Inherited IRA and take the distributions based on his or her own life expectancy.

If, instead, a trust is named as the beneficiary and there is no language to the contrary, the retirement assets will be distributed to all beneficiaries based on the oldest beneficiary’s life expectancy. For example, let’s assume that the beneficiaries of your trust are your son, age 50 and your granddaughter, age 1. Your granddaughter will have to take distributions from your IRA based on your son’s life expectancy, which is significantly shorter. The downfall, obviously, is that the tax deferral is cut significantly short. In order for the oldest beneficiary’s life expectancy to be used, the benefiting trust must be a qualifying or “look through trust”. A “look through” trust is one that:

  • Is a valid trust under state law
  • Is irrevocable at death
  • Has identifiable beneficiaries

The trust documents have been provided to the plan administrator on or before October 31 of the year after the year of the owner’s death

Let’s look at an example. Using the beneficiaries and their ages mentioned earlier, the Required Minimum Distribution (RMD) for the first year after your death from a $3,000,000 IRA based on your son’s life expectancy would be $87,719. These monies would then be divided between your two beneficiaries according to the terms of the trust.

If the above requirements are not met, the trust beneficiaries will not be able to extend the post-death required distributions over the life expectancy of the oldest beneficiary. Instead, the IRA will have to be paid out over the next five years following the year of the owner’s death if the deceased owner died before his RMDs were to begin or over the remaining single life expectancy of the deceased IRA owner if the deceased owner was already taking RMDs. This scenario is even worse!

In order to avoid this suboptimal event and extend the distribution of the IRA assets, the IRA must be divided into separate shares, one share for each of your beneficiaries. Additionally, a separate trust needs to be established, one trust for each of the separate shares. These two events must occur BEFORE your death. In our example, then, you would divide your IRA assets into two accounts and draft two trusts, one with your son as beneficiary, the other, your granddaughter. In this case, your son’s distribution would be $43,860 and your granddaughter’s, $18,382. This is a difference of $25,478 from our prior example. This “savings” remains in the account and continues to grow tax deferred.

One IRA account that names different trusts as beneficiaries may work but is not guaranteed. If you want to maintain control of your IRA assets after you are gone and you want them to be distributed according to each individual’s life expectancy, set up separate IRA accounts and separate trusts as beneficiaries of these.

As I mentioned earlier, there may exist compelling reasons to name a trust as the beneficiary of your IRA. These include:

  • Your IRA beneficiary is a minor child.
  • Your IRA beneficiary is disabled and/or incompetent.
  • Your IRA beneficiary is a perpetual spender and cannot relate to the concept of “saving”.
  • You want to make sure estate taxes are paid and what to control from where they are paid.

You, as the IRA owner, are on your second marriage and you want to make sure that your IRA assets go to your lineal descendants, not your spouse’s children who you may not be particularly fond of.

Don’t fret if you have already named your trust as beneficiary of your IRA and are now questioning your decision. It is usually far simpler to change the beneficiary of your IRA than it is to decide who that beneficiary should be.

The most important question you need to ask yourself when designating beneficiaries is, “Who do I want to inherit my hard earned money?” Once that question has been answered, it is just a matter of deciding the best method to accomplish that. Your legal or financial advisor will be able to assist you in accomplishing your intentions.

Disclaimer : The information provided in this newsletter is general in nature and is provided for educational purposed only. This information should not to be construed as investment advice. Investing in equities involves a serious principal risk, and no assurance can be given that the techniques described here will be successful.

The information contained in this newsletter is not a solicitation to sell securities or investment advisory services where such an offer would not be legal. Information included whether charts, articles, research papers or any statement regarding market or other financial information is obtained from sources believed to be reliable. Past performance is never a guarantee of future performance.