War Story – Naming a Trust as an IRA Beneficiary

By Marvin Rotenberg, IRA Technical Expert

We have written several times about the various aspects of naming a trust as beneficiary of an IRA. We have indicated when it would be appropriate to do so, as well as defined the complexities involved with such an undertaking.

One of the most basic things we always advise our readers is if a trust is the beneficiary of an IRA, you do not want to transfer all assets from the IRA into the trust at the death of the IRA owner. That would be a taxable event. Instead, the assets should remain in the decedent’s IRA and the account should be re-titled to appropriately reflect that it has been inherited by the trust as beneficiary. Then, only the annual required minimum distribution (RMD), based on the single life expectancy of the oldest trust beneficiary, should go into the trust unless the trustee is obligated or has a valid reason to distribute more than this amount from the IRA. All the remaining assets stay in the IRA growing on a tax deferred basis.

An example of a properly re-titled inherited IRA is: Fred Jackson IRA (deceased June 19, 2011) F/B/O Adam Hill, Trustee of the Jackson Family Trust, beneficiary.

Because of the depth of knowledge that is required in order to get this process right, we always strongly encourage our readers to seek expert advice when naming a trust as a beneficiary. To illustrate how things can go wrong when naming a trust as an IRA beneficiary, we recently came across a situation that we would like to share with you.

An advisor advised a terminally ill IRA owner to change the IRA beneficiary from his wife to a newly created discretionary trust. When the IRA owner died, the advisor advised the bank to distribute the entire value of the IRA ($608,000) to this IRA discretionary trust. As a result, over $240,000 in unnecessary income taxes and the tax deferral on the inherited IRA was lost forever.

The mistake could not be corrected, because it was not caught until the following year by the accountant who was preparing the trust tax return. The only amount that should have been paid to the trust was the annual required distribution (only about $24,000 in this case), not the entire IRA account balance. Not surprisingly, the advisor was sued for $2 million due to negligence for improperly funding the IRA trust and for advising his client to name his trust as his IRA beneficiary in the first place.