How to Leave Your IRA to a Trust — And Why You Might

OCTOBER 4, 2010 VOLUME 17 NUMBER 31
Last week we wrote about how you can go about leaving your IRA (or 401(k), 403(b), etc.) to a child with a disability. In passing we mentioned that the discussion about how to leave your IRA to any trust could wait for another day. Today is that day. Let’s tackle this as a Q&A session (or, if you prefer, we can call it a FAQ list).

Can I name a trust as beneficiary of my IRA?
Yes. That was easy.

Are the rules the same for 401(k), 403(b) and other retirement accounts?
Generally, yes. If you have more esoteric retirement accounts, talk to someone to make sure you are doing the right thing. What the heck — talk to an expert in any case. Our purpose here is just to give you some background and introduce the language and issues, not to give you direct legal advice.

Before you tell me how to do it, why would I want to name a trust as beneficiary of my IRA?
There are several reasons you might:

  • If you have a child who is a spendthrift, or married to a spendthrift, or who is involved in tax issues or legal proceedings, you might want the retirement account to be protected against creditors.
  • If you worry that your child might get divorced and want to keep your retirement account out of the divorce calculations and proceedings, a trust might help protect the account (and, for that matter, other assets you are considering leaving to that child).
  • You might just want to delay the withdrawal of your retirement account as long as possible. Of course, you could name your child as beneficiary and trust him or her to withdraw the money as slowly as is permissible. With a trust you can help assure that “stretch-out” of the IRA.

Why is my banker/broker/accountant telling me I can’t name a trust as beneficiary?
That used to be the rule, and lots of professionals are not yet caught up. There are also a couple of special rules that apply when you name a trust as beneficiary — though they are not at all hard to comply with, so it’s not clear why advisers get hung up on those rules. Finally, even though the rules permit naming a trust as beneficiary they do not require all account custodians to go along — so your broker might be telling you that, while the rules permit naming a trust, your account can not take advantage of those rules.

If I want to name a trust as beneficiary, what must I do?
There are a handful of requirements. The important ones: give the IRA custodian a copy of the trust (that, by the way, can be taken care of later — but you can do it now if you want), name only one income beneficiary for the trust, and make sure your beneficiary designation comports with the trust set-up and your larger plans. That probably means you should get competent professional assistance, but that’s usually a good idea for your estate planning anyway.

Are there bad things that happen if I name a trust as beneficiary?
Yes, but not very bad. Depending on the ages of all the beneficiaries and potential beneficiaries, you might have shortened the stretch-out time to a period less than the life expectancy of the primary beneficiary.

Uh, could you please repeat that — in English?
Of course. Let’s use an illustration.

Suppose you have three children: Abigail, Ben and Candy. You are OK with Abbie and Ben getting their shares of your IRA in their names — you trust them to make sound judgments about how quickly to withdraw the money, and you don’t want to bother with a trust for them. Candy is a different story. The details of that story don’t matter: you just want to put Abigail in charge of deciding whether to withdraw more than the minimum amount each year from Candy’s share of the IRA.

You can name a trust for the benefit of Candy as beneficiary of 1/3 of your IRA (naming Abbey and Ben as the other two beneficiaries outright). But what will happen if Candy dies before the IRA is closed out?

As it happens, Candy does not have children. You decide to have the trust say that upon Candy’s death the remaining trust interest in “her” share of your IRA will go to Abigail and Ben. Abigail is ten years older than Candy. That all means that Candy will have to make her IRA withdrawals using Abigail’s age and life expectancy.

But wait. Candy does have children?
Well, why didn’t you say so? That makes it even easier. You can have the trust provide that if Candy dies before the last IRA withdrawal her children become the beneficiaries of the trust (and, indirectly, the IRA). As before, we use the oldest potential beneficiary as the determining age — and we are going to assume for the sake of this piece that Candy is older than all of her children. No effect on Candy’s withdrawal rate. But note that if Candy does die, her children will still have to withdraw from the IRA at Candy’s rate, not their own.

What about estate taxes?
Now you’re talking about a whole different kettle of fish (or something). As you know, the estate tax situation is in flux right now, and some states have their own estate tax rules. That makes it very hard to generalize, and unnecessarily complicates this discussion. Suffice it to say that your IRA will be part of your estate for estate tax purposes, and just because there is income tax due on it does not mean that there won’t also be an estate tax liability attached to it. But if your entire estate is worth less than $1 million, you probably are not going to care very much. Stay tuned for a new number to be inserted in that sentence sometime before the end of 2010.

That sounds pretty simple. Could you please make it more complicated?
We’d be happy to, but it’s not required. We could give you information about what lawyers call “conduit” trusts and “accumulation” trusts. We could explain why you can’t have the money go to a charity upon Candy’s death. We could even try to give you some better names for your imaginary children (while still adhering to the A, B and C convention). But for most of our clients, those complications are unnecessary.

The bottom line: it is not that hard to name a trust as beneficiary of your IRA, 401(k) or other qualified retirement plan. You just need to review the rules, and understand why you might want to do such a thing.

It is also permissible to consider all that, try to get the rules straight, and then decide not to bother. One thing that we don’t want to allow you to do, though: ignore the issue, prepare a will that seems to handle all of your assets, and then have an IRA beneficiary designation that doesn’t agree with the rest of your estate plan, imposes an undue burden on your children and beneficiaries, or fails to address your child’s disability, money problems or legal or financial situation.

We hope this has helped demystify a subject that lawyers and accountants often seem to enjoy complicating. Your life, however, tends to be complicated. Please get good legal, financial and investment advice before you decide what you should do.

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16 Responses

  1. ted kosiba

     /  December 28, 2012

    what are the factors for a inherit ira left to a trust, oldest 3 children are 60, 58, 56 years of age. the trust is the beneficiary

  2. In addition to the ages of the primary beneficiaries, the lawyer you consult will want to know:

    1. Was the trust irrevocable, or did it become irrevocable on the death of the IRA owner?
    2. Who else might be a beneficiary? If one or more of the primary beneficiaries died, would the money go to an older uncle? Or are all possible beneficiaries younger than the oldest child?
    3. Does the trust require distribution of the RMD every year? Because if it does, the rules are a little different.
    4. Can the trust be divided into separate shares? Might it be possible to give each beneficiary his or her own age for distribution schedules?
    5. How much money is in the IRA? Maybe it’s not really worth struggling with these issues (if, for example, the IRA is only a few thousand dollars).
    6. What are the beneficiaries’ intentions? If they all expect to simply withdraw all their money over the next couple of years, it might not make any difference.
    7. What are the beneficiaries’ tax brackets? If, for example, all of them have significant investment losses to offset income, it might not be worth the trouble to keep the IRA going (tax-wise, anyway).
    8. What are the administrative costs to keep the IRA? If separate IRA shares will cost, say, $40/year for each beneficiary, is there $40 of tax savings from stretching out the IRA each year?

    How those questions play out with your inherited IRA will vary from person to person. You might want to talk with a lawyer familiar with IRA withdrawal rules and/or an accountant who has gone through the analysis for other clients. The rules are way more simple and straightforward than they were a decade or so ago, but they are still complicated — and the literature you will see on the subject will tend to start from the assumption that stretching out the IRA withdrawals is always preferable and always tax- and investment-wise.

    Good luck. It’s a complicated area.

    Robert B. Fleming
    Fleming & Curti, PLC
    Tucson, Arizona
    http://www.FlemingAndCurti.com

  3. In addition to the ages of the primary beneficiaries, the lawyer you consult will want to know:

    1. Was the trust irrevocable, or did it become irrevocable on the death of the IRA owner?
    2. Who else might be a beneficiary? If one or more of the primary beneficiaries died, would the money go to an older uncle? Or are all possible beneficiaries younger than the oldest child?
    3. Does the trust require distribution of the RMD every year? Because if it does, the rules are a little different.
    4. Can the trust be divided into separate shares? Might it be possible to give each beneficiary his or her own age for distribution schedules?
    5. How much money is in the IRA? Maybe it’s not really worth struggling with these issues (if, for example, the IRA is only a few thousand dollars).
    6. What are the beneficiaries’ intentions? If they all expect to simply withdraw all their money over the next couple of years, it might not make any difference.
    7. What are the beneficiaries’ tax brackets? If, for example, all of them have significant investment losses to offset income, it might not be worth the trouble to keep the IRA going (tax-wise, anyway).
    8. What are the administrative costs to keep the IRA? If separate IRA shares will cost, say, $40/year for each beneficiary, is there $40 of tax savings from stretching out the IRA each year?
    9. Is there a charitable beneficiary somewhere in the trust? If so, the rules just got more confusing and complicated again.

    How those questions play out with your inherited IRA will vary from person to person. You might want to talk with a lawyer familiar with IRA withdrawal rules and/or an accountant who has gone through the analysis for other clients. The rules are way more simple and straightforward than they were a decade or so ago, but they are still complicated — and the literature you will see on the subject will tend to start from the assumption that stretching out the IRA withdrawals is always preferable and always tax- and investment-wise.

    Good luck. It’s a complicated area.

    Robert B. Fleming
    Fleming & Curti, PLC
    Tucson, Arizona
    http://www.FlemingAndCurti.com

  4. Earl Fibish

     /  January 25, 2013

    Dear Mr. Fleming:
    From what I have heard, an IRA owner can also name a Trust as the beneficiary of his IRA, not for the sake of his heirs, but as a vehicle roughly comparable to an IRA LLC. In this manner, the IRA owner can have checkwriting privileges, invest IRA funds in precious metals and real estate, etc. Are you familiar with this other type of trust, and does the IRS approve of them? Thanks very much.

  5. Mr. Fibish:

    I think you might be confusing the concepts of beneficiary designation with a “self-directed” IRA. The beneficiary designation does not have any effect on the administration of the IRA while the original owner is still alive. Some IRA custodians allow the owner wider latitude in making investment choices — if that is your wish you should be looking for self-directed IRA custodians. Even though you may have more control over the money invested in your IRA, though, remember that taking money out of the IRA will result in income taxation — so exercise of checkwriting privileges could have income tax consequences.

    Good luck in your search.

    Robert Fleming
    Tucson, Arizona

  6. Gil Green

     /  May 6, 2013

    Mr. Fleming,

    Thank you for your newsletter.

    I am over 70.5 years old and considering leaving my IRA to a “See Through Trust” that has my 5 grandchildren (Current Ages 11 to 15) as beneficiaries. The Trustee of the Trust is their Father, who will control the IRA until each grandchild is 30 years old, at which time that grandchild can take control of their portion of the IRA and either roll it into their own IRA (and continue the smaller MRD withdrawals) or totally withdraw the IRA, and pay the taxes on the withdrawal. I don’t believe there is any IRA penalty for the total withdrawal.

    My question pertains to what is the MRD for the IRA, if I die, in say, 5 years, and who pays the taxes on IRA withdrawals.

    1. Is the IRA MRD (IRA $value/ Life expectancy) based on my oldest grandchild’s Life Expectancy (LE), one year after my death (age 21, Single life expectancy – IRS table 1) and thereafter calculate LE by subtracting 1 from his/her LE at age 21, or does the Trust have to withdraw all the IRA money in “N” years. N=?

    2. Each year does the trust pay the taxes on IRA withdrawals at Trust tax rates,
    Or,
    Does each Grandchild receive a K1 from the 1041 Trust Tax return, each year, and pay their 1040 individual tax on the IRA withdrawal, at t possibly lower, tax rates.

  7. Mr. Green:

    Your question is way too complicated for a quick off-the-cuff response. You should sit down with a lawyer and/or CPA to review your fact situation. You will need to show them a copy of the trust so they can be sure.

    I can tell you that there will likely be a K1 for each grandchild, but there is a possibility that the trust may pay tax on some of the income and each grandchild pay the tax on the rest of the taxable income. I can also tell you that your question, though too detailed for an easy answer, is a fun one.

    Robert Fleming
    Fleming & Curti, PLC
    Tucson, Arizona

  8. Michelle Sy

     /  May 9, 2015

    Dear Mr. Fleming,

    I was researching that a person can leave a Roth IRA to a non-spouse heir (i.e. a minor child) without the tax consequences or IRA withdrawal penalty even if you name the beneficiary as the trust. It that true?

    Also, I read that if you were to name a trust as a beneficiary for a 403b or a 401k, unlike an IRA, all the money in the 403b or the 401k goes into the trust right away and therefore doesn’t take advantage over the possible stretch out. And there’s a required minimum distribution? is this correct?

    Thank you!

  9. Ms. Sy:
    Almost perfectly correct. I would explain it in a slightly different way:
    1. Taxes and penalties. There is no tax or penalty on the withdrawals from a Roth IRA, regardless of the age of the beneficiary. This is true regardless of whether the beneficiary is a minor, a person under the sometimes magical age of 59 1/2, a trust or a charity.
    2. Minimum distributions. The mandatory withdrawals required (from an inherited Roth IRA) are based on the age of the beneficiary and, sometimes, the age of the original owner. But if there is no tax on the withdrawal, why do we care about minimum distributions? Because, as you intimate, leaving the money in the account to grow without future income tax effect is even more efficient/productive than having to take it out on a fast forced schedule.
    So is it true that naming a trust as beneficiary means that the Roth IRA has to be collected “right away”? No, not quite. If the trust is constructed properly (depending, of course, on the individual facts), the “stretch-out” period can be as long as the trust’s beneficiary’s life expectancy. Talk to your estate planning lawyer about balancing your goals, the set-up costs and the Roth IRA’s size to come up with your best plan.
    Looking at your questions, I see that you might not be asking about a “Roth” 401(k) in the second one. My answer (above) will work for a non-Roth 401(k) or a 403(b), too, though. Naming a trust as beneficiary does not always accelerate the minimum distribution pace.
    Note that this assumes the account custodian can cope with naming a trust as beneficiary. Not all do. But the trustee should be able to roll over the 401(k) or 403(b) account to a trust-owned IRA even if the custodian is not cooperative. Talk to your lawyer about the mechanics of that process, too.
    I hope that helps. Good luck; this stuff can be more complicated than it ought to be.

    Robert B. Fleming
    Fleming & Curti, PLC
    Tucson, Arizona

  10. Bill Downey

     /  December 9, 2015

    1Have standard IRA. Can it be left to a non-spousal Trustee with directions that the IRA be split up into IRAS for five beneficiaries one which would be the Trustee.
    2 Goal is to have trustee manage IRAs until her death at which time remaining beneficiaries would take iras and do what they want with them . All beneficiaries over age 45 only one which is good money manager.
    I am way past 70 1/2 Am impressed with your knowledge of the IRA to Trust issue. Every other Lawyer says not to do it.

  11. Mr. Downey:

    1. Simple answer: yes. There are some (not really complicated) rules to be followed, and you should make sure the lawyer setting up the trust and revising the beneficiary designation knows what she’s doing, but yes it can be done.

    2. You have identified one of the good reasons an IRA owner might want to create a trust to handle the IRA after the owner’s death.

    Note that the IRA custodian probably will not simply transfer the IRA to the five beneficiaries (or their children) on death of the manager/beneficiary. There will need to be a new trustee or trustees, and the actual structure is very slightly more complicated than you have described. But your ideas are sound, and your goals can be accomplished.

    Good luck, and thanks for the nice compliment.

    Robert B. Fleming
    Fleming & Curti, PLC
    Tucson, Arizona
    http://www.FlemingAndCurti.com

  12. Nick Graham

     /  May 26, 2016

    Dear Mr Flemming.

    My father past away in Februrary and he left his traditional IRA to an irrevocable trust. The beneficiaries are his spouse(not our mother), me and my sister. He had it set up that the beneficiaries of his trust were a trust in my name and my sisters name. THe IRA is now in my fathers trusts name at the financial institution

    1. Can we roll over his spouses portion now and take her out of it and then base the RMD on our ages if my sister and I remain in my dad’s trust until after Sept 30,2017?

    2. Can we elect to not have the $ go into our own personal trusts, instead move the money over to us each individually and have the RMD apply on our individual ages. My dad’s original trust permits this, but the IRA is currently under my fathers trust name at the financial institution.

    The financial institution says I can have them do whatever, but I am worried that if we do this wrong, taxes will bite us later.

    Thanks

  13. Nick:

    You can probably (with the trustee’s consent, anyway) roll your father’s IRA into separate inherited IRAs. But you would be well-advised to sit with a lawyer to plan out the technique. Remember that the trustee’s interest is to make its own work easier, but not necessarily to minimize (or maximize the delay in) your taxes.

    Inherited IRAs are confusing, and not very many practitioners (trustees, lawyers, accountants, brokers) deal with them very often. Make sure you find someone who knows what she’s talking about.

    Good luck.

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