Trust as IRA Beneficiary
There are definitely some traps for the unwary when naming a trust as the beneficiary of the IRA. Naming a trust as the beneficiary of the IRA may seem like the most practical and logical alternative. A trust will allow you to control the distribution of the assets and ensure the IRA meets your “stretch” objectives. However, naming a trust as an IRA beneficiary raises a number of potential traps for the unaware and should be taken with great care. Here are the most common and I believe your fact situation may fall into one of these traps if the document wasn't written with an eye to naming the trust as an IRA "designated beneficiary".
Only individuals may be considered “designated beneficiaries” by the IRS for purposes of taking advantage of the stretch IRA provisions. A person who is not an individual, such as an estate or a charitable organization, may not be a designated beneficiary. If a person other than an individual is named as a beneficiary of the trust, then the IRA is treated as having no designated beneficiary. The IRA would be considered to have no named beneficiary, and thus the entire IRA would be required to be distributed within five years of the date of death of the IRA owner (if the owner had not yet reached the age of 70½) or over the remaining life expectancy of the IRA owner (if the owner had reached the age of 70½). Therefore, a trust named as beneficiary of an IRA should never provide for a charity as well as the children – for example, 45% each to your two children Susie and Billy and 10% to your alma mater.
Another trap involves the requirement that the trust be considered a conduit trust in order to take advantage of the stretch IRA provisions. In order to be considered a conduit trust, the trust should mandate that amounts distributed from the IRA as required minimum distributions be distributed and paid out by the trust to the trust beneficiaries. If this trust provision is not included, the trust is assumed to be able to accumulate the IRA distributions instead of paying them out. This can cause numerous issues. The IRS will count all potential beneficiaries of the trust as beneficiaries of the IRA for purposes of determining the life expectancy to use when calculating IRA distributions. The IRS may have to look far down the line of trust beneficiaries. If an individual in the line of trust beneficiaries is much older than the others, it may cause distributions to be taken out over that person’s shorter life expectancy. As an example, let’s say a trust names two children, ages 13 and 15, as 50% beneficiaries. The trust will hold the assets for the benefit of the children until they reach the age of 30, at which point they will receive the full distribution of their trust share. If the children are not living, the trust assets pass to Uncle Joe, who is 67 years old. In this case, the IRS would pass by the children and use Uncle Joe’s age of 67 to determine the appropriate IRA distribution.
Trusts are often written to provide flexible provisions of how trust assets may be distributed. In the case of a trust that has the ability to accumulate IRA distributions (i.e., no conduit trust provisions), this could become a problem. If one of the trust provisions allows for charitable giving, even if no specific charities are listed, these charities would most likely be considered by the IRS as contingent beneficiaries of the IRA. Since charities are not individuals, the IRA would be treated as having no designated beneficiary, and distributions would need to be taken within five years of death or the life expectancy of the IRA owner, as described earlier.
I know there are a number of IRS rulings that allow a trust that provides for multiple beneficiaries to split into fractional shares, one for each beneficiary. Then each beneficiary can stretch based on his/her own life expectancies. I won't go into those details here because I am not sure your fact situation is appropriate. If you can get over the first couple of traps that would prevent the trust from using a stretch payout, we can talk further about this matter. I am not your legal counsel for the Trust, and do not render any tax advice, but only provide the information above as a courtesy to your legal counsel.
Click here to download the article.
SECURITY PLANNING GROUP, INC.
Admitted USTax Court, 1987
Cal. Ins. Lic. 0768932
IRS CAF No.: 036-45708R
Information Not Legal Advice. This article has been prepared for general information purposes only. The information in this article is not legal advice. Legal advice is dependent upon the specific circumstances of each situation. Also, the law may vary from state to state, so that some information in this article may not be correct for your jurisdiction. Finally, the information contained in this article is not guaranteed to be up to date. Therefore, the information contained in this article cannot replace the advice of competent legal counsel licensed in your state.
Disclaimer of Warranty. The material, information and opinions expressed in this article are provided without any warranties, express, implied or statutory. Any and all implied warranties of merchantability or fitness for a particular purpose are hereby disclaimed.