Why You Should Not Name a Trust as an IRA Beneficiary?
“For obvious reasons, including control, privacy, asset protection, etc., many clients are interested in putting assets into a trust. For many retirees, their IRA is among their biggest assets. It’s only natural to want to put the IRA into a trust.”
An IRA may not be placed into a trust while the account owner is alive. It is important to name a contingent beneficiary for an IRA to provide protection in case the primary beneficiary predeceases the account owner. An IRA also may not be owned by more than one person. The IRA owner can name a trust as a beneficiary of an IRA. Just because you can do this, does not mean it is a good idea, says the article “Naming Your Trust as an IRA BeneficiaryThe Press of Atlantic City. The IRA owner could also take all of the funds and deposit them into a trust, but that would be another bad idea. Why? It is because all of the funds withdrawn would be subject to income tax. For a deceased IRA owner, the rules governing distributions from inherited IRAs can be complex and impacted by legislation like the SECURE Act.
Therefore, why would anyone want to name a trust as the beneficiary for an IRA? Including the term ‘IRA assets’ here provides clarity.
- If you want an heir, like a second spouse, to inherit the income but not the balance of the principal after you have died. This is done so the second spouse cannot name their children as the beneficiary, instead of the original account owner’s children. This has significant implications for the IRA owner’s surviving spouse.
- If you are concerned with the ability of heirs to manage your IRA funds wisely, a trust can be the beneficiary and you can set the terms with which the heirs can have access to the funds. However, inherited IRA assets can be complex and may have potential tax implications.
- Minor children cannot be direct beneficiaries of an IRA, and a disabled child may become ineligible for government benefits, if he or she receives an inheritance directly. Trust beneficiaries must follow required minimum distributions (RMDs) which can impact the financial strategy.
- If you want your IRA funds to be inherited by grandchildren instead of children, a trust is the way to go. This can affect the life expectancy calculations and distribution strategy.
- If creditor protection is a concern under the laws of your state, a trust would keep the IRA funds from being tapped by claims of creditors. This has implications for retirement assets and potential tax consequences.
Here is why you would NOT want to name a trust as the beneficiary of your IRA:
- There are no tax benefits to having the trust inherit your IRA. This is particularly relevant for Roth IRA accounts, where distribution rules differ.
- Trusts have expenses. Trustee fees and tax rates on funds left inside the trust, but not in the IRA, may be substantially higher than personal income tax rates, depending on the beneficiary. This is a concern for IRA owners considering the financial repercussions.
- The trust will have to keep going long after your own death. That means tax returns must be filed, fees paid, and the trustee must maintain the trust. This is an ongoing responsibility following the IRA owner’s death.
- Some companies that hold IRAs do not allow trusts to be beneficiaries of IRAs. Before you get into figuring out if this is the right route for you, find out first if your custodian will permit it. This is crucial if the IRA owner dies and there are potential limitations.
There are many other facts to consider before deciding to name a trust as the beneficiary of an IRA. For example, the implications for a surviving spouse and the potential tax consequences should be carefully evaluated. Speak with your estate planning attorney to see if it is a suitable solution for you and your family.
Reference: The Press of Atlantic City (February 13, 2020) “Naming Your Trust as an IRA Beneficiary”
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