Trusts and IRAs often have an uneasy partnership. Before making this decision, do your homework and enlist the help of knowledgeable sources.
How much control you want beneficiaries to have, is one of the factors to be considered when making decisions about trusteed IRAs, according to a recent article in Financial Planning’s article, “When you should establish an IRA as a trust.”
Tax laws say that an IRA can be established as a trust or custodial account. With a trusteed IRA, a financial organization adds trust terms and language to the plan, so the IRA itself becomes a trust. The financial organization acts as the trustee. The account is administered under the trust provisions both before and after the IRA owner’s death. The owner typically has greater control and provides less control for beneficiaries.
A trusteed IRA is effectively a conduit trust where the trustee must pay out the annual required minimum distributions to the beneficiaries. In order to ensure the stretch IRA for beneficiaries, some trusteed IRAs also allow distributions beyond the RMDs for health, education, and other support. However, trusteed IRAs are standardized documents, so there will likely be some limits on the post-death control options.
Those who have large IRAs and other extensive assets, already may be using trusts as part of their overall estate planning strategy. For those individuals, costs are not a concern and they’d likely be best-served by naming a trust as their IRA beneficiary. For others, whose IRA is their largest asset, a trusteed IRA may make sense. A trusteed IRA usually costs less than a trust to create.
An advantage of a trusteed IRA is: if the IRA owner becomes incapacitated, trusteed IRAs often have a provision that lets the trustee take the RMD on their behalf. Some trusteed IRAs also allow distributions beyond the required minimum distributions for health, education, and other support. This wouldn’t be possible with a trust or an individual named on the IRA’s beneficiary designation form. The trustee can also make lifetime investment decisions and pay any IRA-related fees or expenses.
A trusteed IRA may be a good strategy for those whose primary concern is preserving the stretch for their beneficiaries, because it can limit yearly distributions to the amount of the RMD and preserve the stretch IRA. However, if a trust is named as the beneficiary of an IRA, and it meets the look-through rules, the beneficiary of the trust can use the stretch and take RMDs over the life expectancy of the oldest trust beneficiary.
When an IRA owner names a beneficiary outright, the owner has no say in what happens to the funds after the death of the beneficiary. But a trusteed IRA gives the IRA owner the ability to name successor beneficiaries, which can be useful in second-marriages, where the IRA owner wants to provide for a spouse during his or her lifetime but then ensure that the IRA funds go to children from a prior marriage.
A trusteed IRA offers a higher level of protection from creditors than leaving assets outright to a beneficiary. However, this is somewhat tempered by the fact that the trusteed IRA must to pay out the RMDs each year to the beneficiary, and there’s no way to protect the RMD funds.
It is possible to name a trust as the IRA beneficiary to gain a higher level of protection. A trust could be created to give the trustee the discretion to keep the RMDs in the trust, instead of paying them out to the beneficiaries. The downside to using a trust to protect the RMDs from creditors is the tax at trust tax rates of up to the top 39.6% income tax bracket. A Roth IRA left to a trust could avoid this issue.
Those considering trusts often want to appoint an individual as a trustee. Sometimes, it’s an individual as co-trustee with a financial organization. This won’t work with a trusteed IRA, because the trustee will be the financial organization offering the trusteed IRA. The tax code doesn’t permit an individual to be a trustee of an IRA.
A drawback to trusteed IRAs is the lack of ability to move the inherited IRA assets. There’s no reason why a trusteed IRA couldn’t allow the movement of inherited IRA funds after the death of the IRA owner, but these documents are usually drafted so that it’s either prohibited or not guaranteed.
Give careful consideration to simply designating a beneficiary on the IRA beneficiary form, until you have an opportunity to fully explore how a trusteed IRS might work for your situation. An experienced estate planning attorney at Cottrell & Jacobs will be able to clarify what will occur in any scenario.
Reference: Financial Planning (May 31, 2017) “When you should establish an IRA as a trust”