Should you name a trust as an IRA beneficiary?

Advisers recommend the strategy for clients with large retirement accounts, but it's a maneuver that may confuse many practitioners because the rules are complex

Feb 22, 2019 @ 2:22 pm

By Greg Iacurci

Financial advisers may be wondering how to best bequeath clients' individual retirement account assets to heirs in the event of their death. The question becomes, should they name a trust rather than an individual as a beneficiary of the IRA?

There are many pros and cons to doing so, and practitioners often stumble through the web of complex rules, tax and estate planning experts say. But getting it right is critical.

"It's important because for the overwhelming majority of clients, it's their biggest asset," Richard Behrendt, an estate planner and former attorney at the Internal Revenue Service, said of IRAs.

"But it's tricky," he added. "Even a lot of attorneys don't know exactly how to do this, in my experience."

Individual retirement account assets can't be put into trusts directly during a client's lifetime without destroying the IRA's tax shelter. Rather, a trust must be named as the beneficiary of the client's IRA. The trust would inherit the IRA upon the client's death, and beneficiaries of that trust would have access to the funds.

Asset protection is the primary reason to do this. Trusts shield IRA assets in the event of lawsuits, business failures, divorce and creditors, for example. While taxpayers enjoy state and federal protections for IRA assets during their life, heirs who inherit an IRA directly — not through a trust — lose those protections.

Trusts also allow for a measure of control over the assets. The terms of a trust can dictate how distributions are made in the event that an heir is a minor, disabled, financially unreliable, incapacitated or vulnerable to being preyed upon, for example.

"Some people call it ruling from the grave," said Ed Slott, who heads an eponymous retirement advice firm.

(More: The AMT is no longer a problem for many clients)

Naming a trust as an IRA beneficiary is less practical for those who plan to bequeath their IRA to a spouse, as opposed to children, grandchildren or other heirs. Spousal rules are more lenient, said Mr. Behrendt. Spouses can roll over the decedent's IRA assets into their own IRA tax-free.

Clients may find the cost to create and maintain a trust, as well as the associated complexity, disqualifying.

"If you're going to inherit $50,000, by the time you pay the trustee or accountant, it's not worth it," said Steven Siegel, president of The Siegel Group.

There are many technical rules to follow. For one, the IRA beneficiary form must indicate before a client's death that the trust is the primary beneficiary. After death, the IRA must be retitled as an inherited IRA.

And required minimum distributions would still be required for the IRA. This is one area where selecting the proper type of trust is important — advisers recommend selecting what's known as a "see-through" or "look-through" trust.

Structuring a trust this way maintains the IRA's preferential tax treatment, allowing a trust beneficiary to spread RMDs over a long period of time based on his or her life expectancy, what's known as a stretch IRA. The RMD amount would be based on the oldest beneficiary of the trust. However, beneficiaries with separate trust shares would have different RMDs — a 30-year-old would take larger RMDs than a 16-year-old, for example.

The trust's language must also indicate that distributions from the IRA can only go to "designated beneficiaries," rather than going to pay expenses, for example, said Mr. Behrendt, owner of Behrendt Law.

The risk of not structuring the trust as a see-through or including this language, Mr. Behrendt said, is the IRA assets are distributed and the resulting tax paid within a much shorter time frame, potentially five years.

Trusts may also be structured as "conduit" or "discretionary" trusts, Mr. Slott said.

(More: Limited deduction rubs SALT into taxpayer wounds)

In a conduit trust, annual RMDs pass through the trust to beneficiaries, who pay tax at their individual rates. Discretionary trusts don't distribute the RMDs out of the trust, with the downside of paying tax at the more punitive trust tax rates but the upside of maintaining the most post-death control over assets, Mr. Slott said.

A Roth IRA, the assets of which have already been taxed, skirts the trust-tax issue of discretionary trusts, he added.

0
Comments

What do you think?

View comments

Upcoming event

Sep 24

Conference

Diversity & Inclusion Awards

Attend an event celebrating diversity and inclusion as well as recognizing those who are leading the financial services profession in this important endeavor. Join InvestmentNews, as we strive to raise awareness, educate and inspire an... Learn more

Most watched

Events

Finding innovation in your firm

Adam Holt of AssetMap explains how advisers understand they need to grow, but great innovation may be lurking right under your nose.

Events

Finding your edge from Tony Robbins

Guru Tony Robbins has helped a lot of people, but armed with his psychology Financial Advisor Josh Nelson has helped his practice soar.

Latest news & opinion

How to battle sequence-of-returns risk

Retiring during the longest-running bull market in history can be scary, as some begin to wonder when the good times will end.

Tony Robbins loses role with RIA amid charges of sexual misconduct

String of allegations costs the self-help guru his gig as chief of investor psychology at Creative Planning.

SEC sets June 5 date for vote on Regulation Best Interest

Commission adds new item to agenda: Interpretation of broker guidance that qualifies as advice

House passes SECURE retirement bill with massive bipartisan support

The measure allows small employers to band together to offer plans and raises the RMD age. Another provision eases use of annuities in 401(k)s, which critics say goes too far

10 IBDs with the most annuity revenue

Here are the independent broker-dealers that brought in the most annuity revenue last year.

X

Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting investmentnews.com? It'll help us continue to serve you.

Yes, show me how to whitelist investmentnews.com

Ad blocker detected. Please whitelist us or give premium a try.

X

Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print