Why Name a Trust as IRA Beneficiary?
Even though there are no tax benefits, there may be circumstances when clients
should name a trust as their IRA beneficiary. Trusts, however, create unique
problems and tax complications even when executed perfectly. IRA beneficiary
trusts cannot provide the answers for tax and personal solutions that many
IRA owners are looking for. And quite often trusts are poorly drafted and cause
more problems than they are worth.
IRA owners can name trusts as IRA beneficiaries as a way to better control
post-death IRA distributions and restrict access for IRA beneficiaries who
might otherwise squander large inherited IRAs.
Instead of naming a person (for example a child or grandchild) as a direct
beneficiary on the account, a trust would be named. The trust beneficiary would
be the child, grandchild, or other person that the IRA owner wants to receive
the IRA.
An adult IRA beneficiary may need help with managing the IRA funds and taking
required distributions. The trust could be used to protect your beneficiary
from unscrupulous people who might take advantage of him or her, or from creditor
problems, although most states (but not all) already protect IRAs from
creditors without a trust.
Or suppose that you want to control the ultimate disposition of your IRA.
In a typical second marriage situation (or even with some first marriages),
you may want to leave your spouse the annual IRA income, but after survivor’s
death you want to make sure that the IRA goes to the children and not to the
children from the spouse's first marriage.
Or suppose you fear that if you leave your IRA outright to your son, his spouse,
whom you dislike, will find a way to get at the IRA. Even though the
IRA inheritance is legally your son’s separate property, could his spouse
talk him into liquidating the IRA. If you name a trust as the IRA beneficiary,
your son won’t be able to liquidate the IRA even if he wants to.
A trust can be used to hold money for estate taxes if there is a risk that
the IRA beneficiary will take the money and run without paying his share of
the estate tax. When an individual is a direct beneficiary of an IRA, the entire
IRA goes to that person at death. There is usually a clause in the will called
the "tax apportionment clause" which spells out who is responsible
for the estate tax, both on items that pass through the will and on property
that passes outside the will, such as an IRA or life insurance. But even if
the will's tax clause states that the IRA beneficiary must pay his or her share
of the estate tax from the IRA proceeds, it may be too late if the beneficiary
has already fled with the newly inherited funds. A trust could escrow a portion
of the IRA for estate taxes. This would not apply to a nontaxable estate, where
assets are under $2 million (for 2006-2008).
If the trust is appropriate, it must qualify under the various IRS rules in
order for the trust beneficiaries to be able to use their own life expectancy
for calculating post-death required distributions. If the trust does not qualify,
the stretch IRA option is lost.
The IRS requirements for a trust to qualify as a designated IRA beneficiary
are:
- The trust must be a valid trust under state law
- The trust must be irrevocable at death
- The beneficiaries of the trust must be identifiable
- A copy of the trust document must be provided to the plan by October 31
of the year following the year of the IRA owner’s death
If these requirements are met, then the trust qualifies as a designated IRA
beneficiary, and the trust beneficiary’s life expectancy can be used
to calculate post-death required minimum distributions. If the trust fails
to qualify, then there is no designated beneficiary and trust beneficiaries
will not be able to stretch post-death required distributions over their life
expectancy. In that case, the IRA will be paid out either under the 5-year
rule (if the IRA owner dies before his Required Beginning Date) or over the
remaining life expectancy of the deceased IRA owner (if the IRA owner dies
after his required beginning date).
|
