Naming a Trust as IRA Beneficiary
By Mike Rahn, CISP
We have a client who is reviewing his IRA beneficiary elections. He is thinking about making his trust—which will hold his other financial assets after his death—the beneficiary of his IRA. What are some of the things he should think about before he does that?
Naming a trust your IRA beneficiary is much less common than naming one or more persons, but it is not altogether rare. Unlike a will—which essentially only identifies who will receive a decedent’s assets—a trust can set conditions or limitations for receiving the assets and identifies one or more trustees to ensure that the decedent’s wishes expressed in the trust are carried out.
But naming a trust as IRA beneficiary can also complicate the otherwise straightforward process of conveying one’s IRA assets to others after death. Here are some things that your client should consider.
Control of Assets After Death
For some, a very legitimate reason for naming their trust as an IRA beneficiary is to control access to the assets after their death. By setting access conditions in the trust document, and naming a trustee to administer them, the decedent can control when the IRA assets become available and in what amount. This could be desirable in certain situations (if the recipients are young, if they are not considered sufficiently responsible, have special needs, etc.)
However, if controlling beneficiary access to the IRA after one’s death is not a consideration, then interposing a trust between the assets and the recipient(s) may create unnecessary—even unwanted—complications.
Spouse Limitations
A spouse may suffer the worst consequences when inheriting IRA assets through a trust. Under current Treasury regulations there is no clear path for a spouse who acquires IRA assets from his deceased partner through a trust to treat those assets as his own, something that is routinely done when the inheriting spouse is a direct IRA beneficiary. As a result, the surviving spouse may be forced to receive the IRA assets—and potentially be taxed, if not a Roth IRA—in an accelerated manner. The IRS may, by private letter ruling (PLR), grant a trust beneficiary spouse the privilege of treating inherited IRA assets as her own. But that is not assured, and the PLR will not only be expensive—as much as $10,000—but could also take months to receive.
Five-Year vs. Ten-Year Payout
Under current Treasury regulations, if the IRA beneficiary is a non-person—such as an estate, charity, or a nonqualified trust—the IRA assets may have to be fully distributed within five years if the IRA owner dies before RMDs begin, or if it is a Roth IRA. The trustee(s) will then pass the assets on to the trust’s beneficiaries, for whatever potential tax consequences there may be.
This is in contrast to a 10-year distribution period for many directly-named nonspouse IRA beneficiaries, a lifetime payout period for spouses and a limited number of nonspouse beneficiaries, or the treat-as-own option for a directly-named spouse beneficiary.
10-Year Payout Based on Oldest Trust Beneficiary
An exception to the five-year period is made for certain “see-through” trusts, which are eligible for the 10-year beneficiary distribution period. If eligible—and if annual payments are required—the minimum amount required for the trust and its beneficiaries to receive annually will be based on the age of the oldest trust beneficiary. For younger beneficiaries of the trust, this will be more rapid than would have been the case if they had been directly-named IRA beneficiaries. And of course, if a spouse had been one of several directly-named IRA beneficiaries, she would have had the option to distribute her share and roll it to her own IRA. Not so if inherited through a trust.
Difficulty Changing Beneficiary Status
The life of trusts can vary considerably. Some are lengthy, including those intended to provide financial resources to trust beneficiaries over a long period of time, as well as trusts with provisions for “remainder” beneficiaries if an initial trust beneficiary does not deplete all assets. On the other hand, some trusts have a shorter lifespan, potentially shorter than the five or 10 years that Treasury regulations allow for IRAs to distribute their assets to beneficiaries.
Sometimes, including situations like these, trust beneficiaries will approach the IRS and ask for the right—through a PLR—to be treated as de facto beneficiaries of the IRA. The IRS may grant this, depending on circumstances, including review of the terms of the trust instrument itself. As noted above, however, this can be a lengthy and expensive process. What’s more, a common thread running through such PLRs has been that the distribution options will be no more generous for that individual than would be allowed for the trust.
This is not without benefit, as it does give direct control of an IRA or share of an IRA to a trust beneficiary. But in such cases the distribution requirements will likely not be as favorable as if that person had been named the direct IRA beneficiary.
In Conclusion
In short, there should be a reason or objective behind a decision to name a trust as one’s IRA beneficiary. And as always, it’s wise to advise your client to seek competent tax and/or legal advice when making a decision as important as this one.
