Should a Trust be the Beneficiary of my IRA?
To avoid probate (which can be a costly and tedious Court proceeding), we often create a Revocable Trust which acts as a container to hold assets. At death, the Successor Trustee distributes the trust assets as directed in the Trust document, with no need for a probate court order.
The Trust can direct distribution only of the assets which are re-titled to the Trust. Adding assets to the Trust container, or “funding” the Trust, can be simple or more complicated depending on the type of assets, and how title is currently held.
Whether to include an IRA account in the Trust can be a confusing discussion when I meet with clients. More than any other asset, what will remain in the IRA at death is a “moving target.” While we anticipate the IRA investments will increase in value, the annual Required Minimum Distribution (RMD) beginning at age 70-1/2 may cause the IRA account balance to decline in later years of retirement. This uncertainty makes it hard to predict how best to use the IRA as part of the overall estate plan.
These are some of the relevant points for discussion:
1. An Individual Retirement Account (“IRA”) must be owned by an individual, and thus cannot be re-titled to the Trust as owner. Instead, we look at who will be the Designated Beneficiary to receive the IRA account at the owner’s death. Forms are available from the IRA custodian to update the Designated Beneficiary.
2. The Primary Beneficiary is usually the surviving spouse, both to assure his or her support and to maximize the tax-deferral advantage of an IRA using a “spousal rollover.”
3. Should the Revocable Trust be the designated Contingent Beneficiary of the IRA (or the primary beneficiary if there is no spouse)?
- If optimal opportunity for tax deferral is the most important goal, then it may be preferable to designate the beneficiaries (e.g. the children or grandchildren) by name. If a Trust is the named beneficiary, distribution of the entire IRA may be required within 5 years after the death of the owner, depending on whether the owner had begun the RMD. This means the deferred income tax on those funds must also be paid sooner. By contrast, an individual beneficiary may have the opportunity to “stretch out” the required IRA withdrawals over a longer “life expectancy” period, thus also deferring when the income tax must be paid.
- But tax deferral isn’t the only consideration. Perhaps the protections of a Trust for younger beneficiaries are essential. When IRA funds may be needed sooner for support and education, having a Trustee to properly manage and distribute funds for young or disabled beneficiaries is more important than “stretch out” options for tax planning.
- Another concern is fairness in the event a child unexpectedly passes on. Typically, the IRA would then be distributed to the surviving beneficiaries designated on the IRA form. This may, however, defeat the intended Trust plan to pass on the share of a predeceased child to his or her children (e.g. the grandchildren). With a special attachment to the IRA Beneficiary, we can often achieve both goals.
4. On a final note, naming a tax-exempt charitable organization as the Designated Beneficiary for all or part of an IRA is a fine idea. If you intend to make charitable bequests, an added benefit is avoiding the deferred income tax which a family member or Trust would otherwise pay when receiving an IRA.
Thinking through the “what if” scenarios is the key to deciding who should be the IRA Beneficiary. Once we understand your goals, the professional’s job is to navigate the myriad of IRS laws and regulations applicable to IRAs due to their tax-favored status. The result is a carefully prepared IRA Designation of Beneficiary form directing to whom and how these important benefits will be paid in the future. Prompt review of the IRA following the owner’s death is also important to preserve all available options.
If you have questions about who should be your IRA beneficiaries, call us at 530-272-4292 to review whether an updated Designation of Beneficiary form is needed.