Trusts and IRAs are both complex financial tools, and their convergence can lead to some very expensive problems. The proper selection of retirement account beneficiaries is one of the most important estate-planning decisions you’ll ever make. Generally speaking, you’ll want to designate individuals – rather than the estate – as beneficiaries. This permits the IRA to defer distributions for as long as possible, maximizing growth and the accumulation of wealth. Naming an individual as the beneficiary of the IRA is a simple, strategic way to defer distributions. Sometimes, the easiest answer is the best, and that could mean skipping a trust altogether.
However, there are some good reasons to consider leaving IRA money to a trust – typically for the benefit of someone who might behave irresponsibly. This could be a minor child, a spendthrift, or the spouse from a second marriage. In this last instance, trusts are often set up for those who wish to provide enough money for the care of their spouse, while leaving any remaining funds to their children after the spouse passes.
It’s frequently in the account owner’s best interest to name trusts as beneficiaries of IRAs, since it allows the account owner to have control over the distribution of assets beyond their own death. IRA distributions will then flow into a trust that follows the account owner’s instructions. Legal and tax professionals should be directly involved when determining whether or not to name a trust as a beneficiary, and an advisor may provide guidance by identifying potential issues for the investor to share with their team of professionals.
Your Trust As Beneficiary
Practically anyone or anything can be the beneficiary of an IRA, but only individual heirs can stretch out the minimum required distributions over their expected life spans. If the beneficiary is the estate – instead of an individual – there is no life expectancy for the purpose of calculating the minimum mandatory annual distribution. This means that if the IRA owner dies prior to the required beginning date, the beneficiary isn’t eligible to use the life-expectancy method for the calculation of post-death distributions, and instead must distribute the assets within five years. If the IRA owner dies on or after the required beginning date, the distribution period won’t extend beyond the remaining life expectancy of the deceased. Therefore, naming multiple beneficiaries runs the risk of a dramatically shorter distribution period than the IRA owner would have liked, and this risk is highest when one beneficiary is significantly older than the rest.
Naming a trust as a beneficiary maximizes your control over tax-deferred funds. Since distributions flow into a trust that follows your written instructions, you decide who will receive the money – and when it will be distributed. For instance, the trust could provide the surviving spouse with a steady income for the remainder of their life, and then transfer that income to someone else upon their death. In the event of remarriage, the IRA owner may want their current spouse to receive lifetime distributions, but restrict the spouse’s ability to direct the remainder of the wealth upon their death. This provides protection for remaining funds against irresponsible spending and creditors.
Extending The Benefits
Naming a trust as a beneficiary of an IRA doesn’t offer any tax advantages versus directly naming an individual beneficiary. With a trust, it may not even be possible to both provide for your spouse and extend the tax-deferred growth beyond your spouse’s actual life expectancy. Since the spouse is likely the oldest beneficiary named in the trust agreement, their life expectancy would be used for determining distributions. One way to avoid this limitation is to establish separate trusts for each beneficiary. Using separate trusts (often times called “See-Through Trusts) simplifies things for everyone. Naming each trust as a beneficiary allows you to split the inherited IRA into separate shares for each trust, stretching it over each trust beneficiary’s life expectancy. Many trusts name a charity as the contingent beneficiary that will receive the funds if all human beneficiaries have died, and establishing separate trusts for each beneficiary is particularly effective when one of them is a charity. The charity’s life expectancy – which is zero – will be considered in determining its stretch period, while each individual beneficiary’s stretch period won’t be adversely affected.
There are numerous reasons why a trust may be the best choice as your IRA beneficiary, but you need the assistance of a competent attorney, tax professional or financial advisor to decide if and when a trust is appropriate for your personal situation.
The information herein is general in nature and should not be considered insurance, legal or tax advice. Please consult with an insurance legal or tax professional for additional information on specific situations.
Investment advisory services provided by Werba Rubin Wealth Management, LLC (“Werba Rubin”). Securities transactions are offered through a non-affiliated entity, Loring Ward Securities Inc., member FINRA/SIPC.