Can a Trust Be the Beneficiary of an IRA? Tax Implications, Explained

One of the most important decisions you’ll make in estate planning is deciding who or what your beneficiaries will be — from properties to individual retirement accounts (IRAs). While many people opt to name a spouse, child, or other individual as beneficiary, others consider naming a trust.

As estate planning attorneys, we understand the complexities involved in this decision and the potential tax implications. In this article, we’ll explore the pros, cons, and tax consequences of designating a trust as your IRA beneficiary. We have unique trusts and tax-advantageous plans involving IRAs and the usage of customized trusts.

Understanding the Basics: IRAs and Trusts

Before we dive into the specifics of naming a trust as an IRA beneficiary, let’s briefly review what IRAs and trusts are. An IRA is a tax-advantaged retirement savings account that allows your money to grow tax-deferred or tax-free, depending on the type of IRA you have (traditional or Roth).

Trusts, on the other hand, are legal entities that hold assets for the benefit of designated beneficiaries. They offer a level of control and protection that can be attractive for many estate planning purposes.

There are several reasons why you might consider naming a trust as your IRA beneficiary:

1. Asset protection for beneficiaries who may be minors, disabled, or have trouble managing money responsibly
2. Greater control over how and when distributions are made
3. Potential estate tax benefits in certain situations

Advantages of Designating a Trust as an IRA Beneficiary

Imagine you have a child with special needs who relies on government benefits. Naming them directly as an IRA beneficiary could disqualify them from those benefits due to the inherited IRA being counted as an asset.

However, by creating a Special Needs Trust and naming it as the IRA beneficiary, you can ensure your child’s inheritance is managed properly without jeopardizing their eligibility for essential benefits.

Another scenario where a trust might be advantageous is in second marriages. If you want to provide for your current spouse but ensure that any remaining assets pass to your children from a previous marriage, a trust can help accomplish this goal. The trust can be structured to provide income to your spouse for their lifetime, with the remainder going to your children.

Disadvantages and Tax Implications

While there are clear benefits to naming a trust as your IRA beneficiary, there are also some drawbacks and tax implications to consider.

One significant disadvantage is the loss of the spousal rollover option. When you name your spouse directly as your IRA
beneficiary, they can typically roll the inherited IRA into their own IRA, allowing the assets to continue growing tax-deferred or tax-free (in the case of a Roth IRA).

This “stretch” IRA strategy can be powerful for extending the tax benefits across generations. However, when a trust is named as the beneficiary, this option is lost.

Additionally, trusts have compressed distribution timelines under the SECURE Act, which was passed in December 2019.

The SECURE Act’s Impact on Inherited IRAs and Trusts

The Setting Every Community Up for Retirement Enhancement (SECURE) Act significantly changed the rules for inherited IRAs. Previously, non-spouse beneficiaries could “stretch” distributions from an inherited IRA over their lifetime.

Now, most non-spouse beneficiaries (including trusts) must fully distribute the inherited IRA within ten years of the original account owner’s death.

There are some exceptions for eligible designated beneficiaries (EDBs), such as surviving spouses, minor children (until they reach the age of majority), disabled or chronically ill individuals, and beneficiaries who are not more than ten years younger than the original IRA owner.

Qualifying a Trust as a Designated Beneficiary

For a trust to qualify as a designated beneficiary and be eligible for the ten-year distribution rule under the SECURE Act, it must meet certain criteria. These trusts are often referred to as “see-through” or “look-through” trusts.

Under Treasury Regulation 1.401(a)(9)-4, Q&A-5, a trust must meet the following requirements to be considered a qualified “see-through” trust:

1. The trust must be valid under state law (in this case, New York law).
2. The trust must be irrevocable or become irrevocable upon the death of the IRA owner.
3. The beneficiaries of the trust must be identifiable from the trust document.
4. A copy of the trust document must be provided to the IRA custodian or plan administrator by October 31st of the year following the year of the IRA owner’s death.

Conduit Trusts vs. Accumulation Trusts

There are two main types of see-through trusts that can be named as IRA beneficiaries: conduit trusts and accumulation trusts.

A conduit trust requires that any distributions from the inherited IRA be paid directly to the trust beneficiaries. The trustee cannot retain any of the distributions within the trust. This can be advantageous if you want to ensure the beneficiaries have access to the funds, but it also means the distributions will be taxed at the beneficiaries’ individual income tax rates.

An accumulation trust, on the other hand, allows the trustee to retain some or all of the IRA distributions within the trust. This can provide greater control and asset protection but may result in higher taxes, as income retained in the trust is taxed at trust tax rates, which are typically higher than individual rates.

Best Practices for Naming a Trust as an IRA Beneficiary

If you’re considering naming a trust as your IRA beneficiary, there are some best practices to follow:

1. Consult with an experienced estate planning attorney to ensure your trust is properly drafted and aligned with your goals.
2. Make sure your trust provisions comply with the IRS rules for see-through trusts.
3. Keep your beneficiary designations up-to-date and coordinate them with your overall estate plan.
4. Consider alternative strategies, such as naming the trust as a contingent beneficiary after your spouse.
5. Review and update your estate plan regularly, especially after major life events or changes in tax laws.

Balancing Competing Priorities

Ultimately, the decision to name a trust as your IRA beneficiary depends on your unique situation and priorities. You’ll need to weigh the benefits of asset protection and control against the potential tax consequences and complexity.

For example, let’s say you have a sizable IRA and want to provide for your spouse while also ensuring that your children from a previous marriage ultimately inherit the remaining assets. In this case, you might name your spouse as the primary beneficiary and a trust for your children as the contingent beneficiary. This would allow your spouse to take advantage of the spousal rollover option while still protecting your children’s inheritance.

Ensure Your IRA Beneficiary Designations Align with Your Goals

Naming a trust as your IRA beneficiary can be a smart estate planning strategy in certain situations, but it’s not a one-size-fits-all solution. It’s essential to understand the tax implications and potential drawbacks, such as the loss of the spousal rollover option and the compressed distribution timeline under the SECURE Act.

As estate planning attorneys, we highly recommend consulting with a professional to ensure your trust is properly drafted and aligned with your goals. We can help you navigate the complex rules surrounding inherited IRAs and trusts, ensuring that your beneficiaries are protected and your wishes are carried out.

If you have questions about naming a trust as your IRA beneficiary or would like to review your estate plan, please contact the Katz Law Firm. Our experienced attorneys are here to guide you through the process and help you make informed decisions that best serve your unique needs.