Many of us have understood the value of saving in our IRA as well as the value of creating a trust, but should a trust account be the beneficiary of an IRA? This is a complex question for many to answer. Not only are the rules surrounding IRA accounts and their required minimum distributions (“RMDs”) complex, the rules are different for inherited accounts or “stretch IRAs” that may prolong some of the tax advantages of IRA accounts beyond the life of the account holder. Let’s look at some of the advantages and disadvantages of naming a trust as an IRA beneficiary:
Pros of Naming a Trust as Your Beneficiary
Although generally fine to name a natural person as your beneficiary, there are a handful of situations where the trust may provide an advantage.
Blended Families: Many families have children from more than one marriage. A properly drafted trust can ensure that the assets pass according to the wishes of the account holder to all intended beneficiaries.
Minor Children: Naming a minor child as the beneficiary of an IRA account may result in a court-appointed guardian being named to assist. This can be a complex and costly process that may reduce the balance of funds received.
Special Needs: Beneficiaries with special needs may risk losing other benefits including Social Security Disability or Medicaid when an IRA is inherited directly.
Creditor Protection: A trust may be able to help shield an inherited IRA from creditors or divorce. The Supreme Court ruled in 2014 that an inherited IRA, unlike your own retirement account, is not protected from creditors during bankruptcy. Consider a trust to protect the ability of your loved ones to retain their inherited IRA should they ever face divorce or bankruptcy.
Cons of Naming a Trust as Your Beneficiary
There are also a few reasons why naming a natural person your beneficiary directly may be preferable to using a trust. Beneficiary designations do have some flexibility. Before we go into some of the advantages compared to a trust, let’s just confirm what your selections may be.
Although there are some variations among account types and custodians, you can usually name one or more natural person or entity (a trust or charitable organization, for example), allocating the account as you wish among them. You can also choose contingent beneficiaries who will inherit assets if the named beneficiaries have died before the account owner updates beneficiaries. The account owner can choose to have the assets flow per capita (to have remaining primary beneficiaries receive the deceased beneficiaries share) or per stirpes (for the contingent beneficiaries associated with the deceased beneficiary to receive the share), a popular option for parents who wish to ensure all grandchildren from multiple children receive an inheritance even if one of their own children dies before they do. The term is Latin for “by branch.” Some custodians allow more advanced options.
Now that we have a basic understanding of what you can do with beneficiary designations, let’s look at some of the advantages of using them instead of a trust.
Errors in Trusts are Possible: The complexity of estate planning means that mistakes can occur along the way if careful attention is not given to the specific circumstances of each individual.
An example of a common mistake may be that the trust is not considered a “see through” or “look through” trust. This could mean that rather than stretching distributions from the IRA over a life expectancy, the account could need to be liquidated within five years. This substantially reduces the tax advantages of the account.
Professional Advice is Needed: For those who wish to name a trust as the beneficiary of their IRA, it is important to work with a knowledgeable attorney experienced in this are in addition to consulting with the financial institution where assets will be held. Your custodian may require additional paperwork for trust beneficiaries.
Simplicity is Preferred: For many, the “KISS Principle” (Keep it simple stupid.) is relevant. Most account holders are well served to name their spouse as beneficiary and children as contingent beneficiaries. For those with more complex situations, a trust may be the best way to accomplish unique goals or deal with less common objectives.
How to Make the Right Decision?
Estate planning can be complex even for simple circumstances. Guidance from a qualified professional with experience in the area is imperative to success with your estate plan.
If these are issues you’ve only recently considered or your existing plans have not been recently updated, please give us a call. We’ve helped clients over the years with legacy goals and can refer to experienced attorneys and other professionals depending on your specific needs and circumstances.