However, there are some good reasons to consider leaving IRA money to a
trust - typically for the benefit of someone who might behave irresponsibly.
This could be a minor child, a spendthrift, or the spouse from a second
marriage. In this last instance, trusts are often set up for those who wish to
provide enough money for the care of their spouse, while leaving any remaining
funds to their children after the spouse passes.
It’s frequently in the account owner’s best interest to name trusts as
beneficiaries of IRAs, since it allows the account owner to have control over
the distribution of assets beyond their own death. IRA distributions will then
flow into a trust that follows the account owner’s instructions. Legal and tax
professionals should be directly involved when determining whether or not to
name a trust as a beneficiary, and an advisor may provide guidance by
identifying potential issues for the investor to share with their team of
professionals.
Your Trust As Beneficiary
Practically anyone or anything can be the beneficiary of an IRA, but only
individual heirs can stretch out the minimum required distributions over their
expected life spans. If the beneficiary is the estate - instead of an
individual - there is no life expectancy for the purpose of calculating the
minimum mandatory annual distribution. This means that if the IRA owner dies
prior to the required beginning date, the beneficiary isn’t eligible to use the
life-expectancy method for the calculation of post-death distributions, and
instead must distribute the assets within five years. If the IRA owner dies on
or after the required beginning date, the distribution period won’t extend
beyond the remaining life expectancy of the deceased. Therefore, naming
multiple beneficiaries runs the risk of a dramatically shorter distribution
period than the IRA owner would have liked, and this risk is highest when one
beneficiary is significantly older than the rest.
Trust Advantages
Naming a trust
as a beneficiary maximizes your control over tax-deferred funds. Since
distributions flow into a trust that follows your written instructions, you
decide who will receive the money - and when it will be distributed. For
instance, the trust could provide the surviving spouse with a steady income for
the remainder of their life, and then transfer that income to someone else upon
their death. In the event of remarriage, the IRA owner may want their current
spouse to receive lifetime distributions, but restrict the spouse’s ability to
direct the remainder of the wealth upon their death. This provides protection
for remaining funds against irresponsible spending and creditors.
Extending The Benefits
Naming a trust as a beneficiary of an IRA doesn’t offer any tax
advantages versus directly naming an individual beneficiary. With a trust,
it may not even be possible to both provide for your spouse and extend the
tax-deferred growth beyond your spouse’s actual life expectancy. Since the
spouse is likely the oldest beneficiary named in the trust agreement, their
life expectancy would be used for determining distributions. One way to avoid
this limitation is to establish separate trusts for each beneficiary. Using
separate trusts (often times called “See-Through Trusts) simplifies things for
everyone. Naming each trust as a beneficiary allows you to split the inherited
IRA into separate shares for each trust, stretching it over each trust
beneficiary's life expectancy. Many trusts name a charity as the contingent
beneficiary that will receive the funds if all human beneficiaries have died,
and establishing separate trusts for each beneficiary is particularly effective
when one of them is a charity. The charity’s life expectancy - which is zero -
will be considered in determining its stretch period, while each individual
beneficiary’s stretch period won’t be adversely affected.
Summary
There are numerous reasons why a trust may be the best choice as your IRA
beneficiary, but you need the assistance of a competent attorney, tax
professional or best local financial advisor to decide if and when a
trust is appropriate for your personal situation.
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