Naming a Trust as an IRA Beneficiary: Is It Right for You?
In planning for your family's security, you may have wondered how to pass on your Individual Retirement Account (IRA) assets in the event of your death. In some cases, you may not want a family member to receive IRA funds directly after you're gone and wonder "can an IRA be in a trust?" If you're considering naming a trust as an IRA beneficiary, that can completely alter how the Internal Revenue Service (IRS) treats IRA distributions. Knowing the pros and cons of this estate planning strategy can help you make the best choice for your circumstances in conjunction with an experienced estate planning attorney.
Naming a Trust as an IRA Beneficiary: Not a Tax Management Tool
Seeking a tax advantage is generally not an adequate reason to put an IRA in a trust. Presumably, your IRA investments have been accruing and growing throughout your career tax-free, but your withdrawals will be taxable. While trusts may help avoid some estate taxes, their usefulness as a tax management device is limited. But that doesn't mean that naming a trust as an IRA beneficiary does not have other benefits. Read on to learn whether this estate planning strategy may meet your needs.
The Pros and Cons of Naming a Trust as an IRA Beneficiary
There are two main reasons to name a trust as an IRA beneficiary. One is protection of IRA assets from the creditors of the beneficiary or beneficiaries. The other is that the grantor can retain control over the distribution of trust assets for the trust beneficiaries even after his or her death. This is beneficial in cases where trust beneficiaries have special needs or addiction problems and would benefit from having their distributions meted out over time.
But putting an IRA in a trust has its drawbacks. Chief among them are the potential tax consequences. Distributions from a trust are taxed at trust rates, which are in most cases much higher than individual tax rates.
Another drawback is the complex treatment of distributions. IRA distributions are made only to the trust, and from there, the trustee makes the distribution to the beneficiary or beneficiaries. Additionally, the trust beneficiaries lack of control over investments once the IRA is in the trust.
Creating a Valid Trust in West Virginia
Naming a trust as the beneficiary of your IRA requires the creation of a valid trust. In West Virginia, for example, W. Va. Code § 44D-4-402 allows a trust to be created only by an order of a court or if the grantor indicates an intention, in writing, to create the trust. A valid trust requires each of the following:
- The trust has a definite beneficiary or is a charitable trust, a trust for the care of an animal, or a trust for a noncharitable purpose.
- The trustee must have duties to perform.
- The same person may not serve as the sole trustee and the sole beneficiary of the trust.
Additionally, the Rule Against Perpetuities requires that the grantor of the trust may name only beneficiaries who may receive distributions within 21 years of a life in being. If you think naming your trust as an IRA beneficiary may be a good fit for you, it's critical to work with an experienced estate planning attorney to ensure you meet requirements like these.
Naming a Trust as IRA Beneficiary Requires Qualification as a "Look-Through" Trust
Before planning to name a trust as the beneficiary of an IRA account, contact the IRA custodian to make sure such a designation is permitted.
Additionally, the trust must qualify as a "look-through" or "see-through" trust. This means that the IRS must be able to "look through" the trust to identify the trust beneficiary or beneficiaries as the ultimate beneficiaries of the IRA. If a trust meets this standard, then the trust beneficiaries can take advantage of the Required Minimum Distribution (RMD) rules that otherwise apply only to individual beneficiaries.
- A trust must meet the following qualifications in order to qualify as a "look-through:"
- The trust must be a valid trust under your state's law.
- The trust must be irrevocable upon the death of the IRA account owner.
- The trust document must clearly identify the individual beneficiaries of the trust.
- The trustee must provide the trust document to the IRA custodian no later than October 31 in the year after the death of the IRA owner.
If the trust does not qualify as a "look-through," the RMD rules won't apply. In that case, the entire balance of the IRA must be paid out by the end of the fifth year after the account owner's death.
Additionally, if the IRA contains "stretch provisions" that would allow the growth on account assets to remain tax-deferred until withdrawn, the trust beneficiaries must be individuals-people with a life expectancy but not other trusts or artificial "persons" under the law.
Naming a Trust as an IRA Beneficiary Requires Expert Legal and Tax Advice
Putting an IRA in a trust is a sound estate planning strategy in certain cases, but this is a highly fact-specific decision that depends on the circumstances of each matter. While financial planners and IRA custodians can assist with many aspects of an IRA, this is one area in which legal and tax advice tailored to your situation and your state's law are essential. Leaving an IRA to a trust is not a do-it-yourself strategy.
The contents of this blog constitute Advertising Material, are intended to convey general information only, do not constitute legal advice, and do not create with the reader an attorney-client relationship with any reader.