Should You Leave Your IRA to a Trust?
By Sarah Brenner, JD
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You may wonder about naming your trust as your IRA beneficiary. For some that may be the way to go, but you should be careful. Trusts are not for everyone. There are trade-offs and consequences. Trusts as IRA beneficiaries create unique problems and tax complications.
Naming a Trust
Many IRA owners will name a living person as beneficiary of their IRA. Often that person is a spouse or child. You could simply name that person on the IRA beneficiary designation form. If you want to name your trust instead of naming a person as a beneficiary on your IRA, you would name your trust on the beneficiary designation form. The trust’s beneficiary could be a child, grandchild or another person that you want to receive the IRA. There are an infinite number of ways a trust can be drafted to best meet your needs.
Naming a trust as an IRA beneficiary is more complicated than naming a beneficiary directly on the beneficiary designation form. It costs both time and money. You will need to consult an attorney to draft the trust which is likely to come with a hefty price tag. Be sure to seek out an attorney with knowledge of both retirement plans and trusts.
Control is Key
The main reason to go with a trust as your IRA beneficiary is control. A trust allows control from the grave over IRA funds. In some situations, there are smart reasons to seek control. For example, if the intended beneficiaries are children or a disabled person, a trust provides a way for you to control the IRA funds for their benefit long after your death.
Minor as Beneficiary
A common reason for naming a trust as an IRA beneficiary is to provide for a child. Minors are not able to make tax elections like IRA distribution decisions or direct investment choices.
There are other beneficiaries who also may need the control that a trust provides. A trust may be advisable if an IRA beneficiary is someone who may need help with managing the IRA funds and taking required distributions, even if the beneficiary is an adult. The trust could be used to protect the beneficiary from creditor problems, as many states do not provide creditor protection for IRA beneficiaries.
A trust can be a good choice in second marriages where you want to control the ultimate disposition of your IRA. You may want to leave your spouse the annual IRA income, but after your spouse’s death you may want to make sure that the IRA goes to your children.
If you have a larger estate, a trust may be needed as part of the overall estate plan. A trust can be used to avoid federal estate tax or inclusion in the beneficiary’s estate. With increased exemption levels and portability, only a small percentage of all estates will be affected by the federal estate tax. However, for those that are, trusts are a necessary tool. A trust may also be a good strategy if you are concerned about state estate tax. Many states have decoupled from the federal estate tax system and have kept lower exemption amounts and do not allow portability.
Reasons Not to Name a Trust
There are some strong reasons not to name a trust as an IRA beneficiary. The main reason not to name a trust is simplicity. By not naming a trust you can avoid restrictions on beneficiaries and trust complications. Another reason not to name a trust is to avoid high trust income tax rates.
Another downside to naming a trust as an IRA beneficiary is the loss of a spouse beneficiary’s ability to do a spousal rollover. This is an option available to a spouse named outright as the IRA beneficiary but not to one who inherits through a trust. There have been many private letter rulings (PLRs) over the years where a trust was named as the beneficiary and spouses have gone to the IRS to request the ability to do a spousal rollover. While the IRS has generally allowed such requests when the spouse has complete control over the trust and its distributions, relief comes with a big price tag.
The Take Away
Don’t name a trust as your IRA beneficiary unless you know what you are doing and it’s the only solution. Be sure that there is good reason to take on the extra expense and complications that will come along with the trust. “My attorney told me to!” is not enough.
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