Should Your Trust Be a Beneficiary of an IRA?

Once a person dies, the Internal Revenue Service requires that the designated beneficiary (“DB”) of an Individual Retirement Account (“IRA”) take minimum required distributions (“MRD”) from the IRA each year. You can take more than the MRD but you MUST take at least the MRD.

Any distribution from a decedent’s IRA is generally taxable when the DB receives the distribution. Thus, if you can extend the time over which the DB takes distributions, then the income taxes can be spread over such time.

Assume Linda has an IRA of $300,000 and she dies and names her son, Mortimer, the DB. Mortimer could take the entire $300,000 at one time and pay income tax on the $300,000 distribution. However, if Mortimer is only 20 years old and can elect, he could take distributions over his life expectancy, which, at 20 years old, is 63 years (according to the IRS single life table). Thus, he would only have to take $300,000 divided by 63 or $4,761 (the MRD) distribution in the first year. After the first year the divisor would be reduced by 1. Meanwhile, the growth in the IRA would be tax free until Mortimer depleted the IRA.

Suppose Linda creates a trust which benefits Mortimer as well as other beneficiaries. If Linda names the trust the beneficiary of the IRA, then the planning gets quite complicated. For Mortimer to use his life expectancy to take distributions through the trust, the trust must meet stringent conditions and qualify as a “see through” trust. The IRS has to “see through” the trust and find an individual beneficiary for whom to take the life expectancy. If there are other beneficiaries of the trust who are older than Mortimer then the IRS may look at the oldest person’s life expectancy and not Mortimer’s life expectancy.

Basically, there are 2 types of qualifying trusts, an accumulation trust and a conduit trust. An accumulation trust is a trust in which IRA distributions payable to the trust can be accumulated by the trustee. For example, Linda’s trust could provide that trust assets are held for Mortimer’s health, education, maintenance and support and then distributed to Mortimer when he reaches age 40. In an accumulation trust the IRS takes into account ALL possible individual trust beneficiaries and uses the oldest individual’s life expectancy to calculate the MRD. If, for example, an uncle is also a remainder beneficiary of the trust, the uncle’s life expectancy, instead of Mortimer’s life expectancy, may be used which would reduce the time of tax free deferral.

A conduit trust REQUIRES that ANY distribution from the IRA payable to the trust MUST be paid by the trustee directly to Mortimer. The life expectancies of other beneficiaries are not considered and Mortimer’s life expectancy can be used. The downside is that Mortimer gets the money and if he is a spendthrift or cannot manage money the trustee has no choice about the distribution.

Which one is better? It depends… on your goals, your desires for your children or other beneficiaries, the likelihood of creditor issues, the likelihood of divorces and spouses, etc etc.

ADVICE: This is NOT an area to take lightly. If you are considering making a trust a beneficiary of an IRA, obtain competent counsel. DO NOT just sign a beneficiary designation and make the trust the beneficiary. The results could be disastrous and require a payout over a substantially shorter period than what you intended.


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