Key Considerations in Naming A Revocable Trust as a Beneficiary of an IRA
IRA account holders typically designate individuals as beneficiaries who will inherit the account upon the account holder’s death – such as “all to spouse” or “in equal shares to children.” However, a trust can also be named as an IRA beneficiary, and in some instances may be a better option than an individual beneficiary. When a trust is named as the IRA beneficiary, the trust inherits the IRA upon the IRA owner’s death. The IRA is then maintained as a separate account that is an asset of the trust.
Some good reasons to consider naming a trust as an IRA beneficiary include:
- Working around beneficiary ownership limitations: Perhaps the intended beneficiary is a minor who is legally unable to own the IRA. Or perhaps the IRA owner wants to support an individual with special needs who would lose access to government benefits if they owned assets in their own name. A solution in both cases could be to name a trust as the IRA beneficiary. On the owner’s death, the trust would become the legal owner of the IRA, and the trustees would administer it for the benefit of the individual who could not own the IRA outright.
- Solving for second marriage or other family structures: An IRA owner may wish for Required Minimum Distributions (RMDs) to benefit a second spouse during the spouse’s lifetime, and then to have the remainder of the IRA pass for the benefit of children from a first marriage. If the IRA owner leaves the IRA outright to a spouse, it is certain that the spouse will benefit, but it is not guaranteed that the children will receive anything. If the owner instead leaves the IRA to a properly structured trust, the desire to benefit both sets of beneficiaries can be ensured.
- Limiting a beneficiary’s access: It is often assumed that IRA beneficiaries will take only the RMDs, but an individual who has inherited an IRA outright has the right to take larger distributions or even withdraw everything from the IRA. As discussed further below, even if most beneficiaries withdraw only the RMDs, for many beneficiaries, all IRA assets may be required to be distributed from the IRA by December 31 of the 10th year following the IRA owner’s death, or sooner. This can result in the IRA assets being fully under the control of the beneficiary sooner than desired. However, if a trust is named as the IRA beneficiary, then the trust terms will determine beneficiary access to the inherited IRA assets.
- Naming successive beneficiaries: When an individual inherits an IRA, the inheritor names their own beneficiaries who will receive the account at the inheritor’s death. If the original IRA owner wishes to determine the successor beneficiary beyond the point of their death, naming a trust as the IRA beneficiary can provide certainty as to whom the subsequent beneficiaries will be.
- Providing creditor protection: A person’s own IRA has some level of protection from creditors, but this does not always carry through to the inherited IRA. The U.S. Supreme Court ruled in Clark v. Rameker, 573 U.S. 122 (2014) that inherited IRAs do not qualify under the Federal Bankruptcy Code as exempt from the claims of creditors as “retirement funds.” Having an inherited IRA owned in a properly structured trust will provide some protection from the beneficiaries’ creditors.
- Funding estate plans structured to minimize estate tax: Most wealthy individuals’ estate plans include trusts designed to minimize and postpone the payment of estate tax. For such estate plans to work as intended, the portion of the trusts that would be sheltered by an individual’s federal or state estate tax exemption likely needs to be funded upon the individual’s death. Often, the only asset available to do this funding is an IRA. In such situations, naming one or more trusts as the IRA beneficiary can further minimize or postpone estate tax.
It is important to involve your estate planning advisor in any decision to name a trust as an IRA beneficiary to ensure that the trust is drafted in a way that will accomplish your goals. You will want to confirm that your reasons for naming a trust as your IRA beneficiary are reflected in the trust terms and will not be negated by the RMD payout provisions and the potentially higher income taxes the trust may pay on income not distributed to a beneficiary. Consult with an experienced estate and tax attorney to discuss the pros and cons of naming your trust as a beneficiary of your IRA. The experienced estate planning attorneys at Beresford Booth can help you make important decisions about your future. Contact us at info@beresfordlaw.com or (425) 776-4100 to see how we can help.