Trust as Beneficiary of Traditional IRA or Retirement Plan

What Is It?

You can create and use a trust as a legal entity to keep assets for the benefit of one or more people, known as the trust beneficiaries. Each trust has one or more trustees who are in charge of administering the trust's assets and allocating principle and/or income to beneficiaries in accordance with the terms stated in the trust agreement. (A person or an organization, such a bank, can serve as a trustee.) A multitude of purposes can be served by employing diverse forms of trusts.

If the administrator of your employer-sponsored retirement plan or the custodian of your IRA permits it, you might be able to name a trust as a beneficiary. The beneficiaries of the trust may be considered the designated beneficiaries of the retirement plan or IRA for the purposes of determining the required post-death distributions, which are required to be made after your death if the trust satisfies specific requirements. There are stronger chances for tax deferral as a designated beneficiary.

Caution: Roth IRAs are not covered by this discussion; it only relates to eligible employer-sponsored retirement plans and standard IRAs. Beneficiary designations for Roth IRAs are subject to special considerations.

Caution: Unless your spouse signs a waiver enabling you to choose a different beneficiary, employer-sponsored qualifying plans may compel you to nominate your spouse as a beneficiary.

Naming a Trust As Beneficiary Usually Will Not Affect Required Minimum Distributions during Your Life

Note: Required minimum distributions are waived for defined contribution plans (other than Section 457 plans for nongovernmental tax-exempt organizations) and individual retirement accounts for 2020.

By April 1 of the calendar year following the calendar year in which you reach age 70½ (age 72 if you attain age 70½ after 2019), you must start taking annual required minimum distributions (RMDs) from your traditional IRA and most employer-sponsored retirement plans (401(k)s, 403(b)s, 457(b)s, SEPs, and SIMPLE plans) (your "required beginning date"). This is mandated by federal law.

When it comes to employer-sponsored retirement plans, you can postpone taking your first payout until April 1 of the year after the year you retire if you meet three requirements: (1) you retire after turning 70½ (or 72 if you turn 70½ after 2019); (2) you continue to participate in the employer-sponsored plan; and (3) you own 5 percent or less of the employer. Generally speaking, the beneficiary you select will not have an impact on how your RMDs are calculated over your lifetime. However, if your spouse is your only named beneficiary for the full payout year and they are younger than you by more than ten years, there is a significant exemption. If you designate a trust as your only beneficiary and your spouse, who is over ten years younger than you, is the sole beneficiary of the trust, you might also qualify for the same exception.

If you name a trust as your beneficiary, the beneficiaries of the trust may be treated as the IRA or plan beneficiaries for purposes of required post-death distributions. This typically means that the trust beneficiaries will be able to use the life expectancy method to calculate distributions after your death (generally based on the life expectancy of the oldest trust beneficiary). See below for additional information.

Caution: In the event that a trust is named beneficiary, the oldest beneficiary is decided after taking into account each beneficiary of the trust. The sole exception is if a beneficiary's benefit depends on another beneficiary passing away before the whole IRA or plan value is paid out.

Caution: The calculation of RMDs is complex, as are the related tax and estate planning issues. For more information, consult a tax professional.

What Rules Must Be Followed for a Trust Beneficiary to Qualify As a Designated Beneficiary?

An underlying beneficiary of a trust cannot be selected as a beneficiary of an IRA or retirement plan unless certain particular conditions are satisfied. Only when the following four trust requirements are satisfied in a timely way may the beneficiaries of a trust be designated beneficiaries under the new IRS distribution rules:

1. The trust beneficiaries must be individuals clearly identifiable (from the trust document) as designated beneficiaries as of September 30 following the year of your death.

   Caution: The "separate account" rules, which would ordinarily permit each beneficiary to utilize his or her life expectancy for computing mandatory post-death distributions, are prohibited from being used by trust beneficiaries, according to final IRS regulations. To achieve this, you might need to create distinct trusts for each beneficiary. Speak with an estate planning lawyer.

2. State law must deem the trust to be legitimate. A trust that satisfies the requirements of the state legislation, subject to the limitation that it does not have a trust "corpus" or principal, will be acceptable.

3. The trust must be irrevocable, or (by its terms) become irrevocable upon the death of the IRA owner or plan participant.

4. By October 31 of the year after your death, the trust agreement, any revisions, and the beneficiary list (including contingent and remaining beneficiaries) must be given to the plan administrator or the IRA custodian.

   Caution: The aforementioned deadline is not applicable if your spouse, who is over 10 years your junior, is the only beneficiary of the trust and you wish to base lifetime RMDs on survivor and joint life expectancy. In this instance, trust records have to be submitted prior to the start of lifetime RMDs.

In addition to these requirements, a surviving spouse will not be considered the sole beneficiary of a trust if any of the IRA or plan funds in the trust can be accumulated during the surviving spouse's lifetime for the benefit of remainder beneficiaries.

Caution: You should consult an estate planning attorney regarding the above requirements, as a mistake may prove costly.

Advantages of Naming a Trust as Beneficiary

A Trust Beneficiary Can Be Treated As the IRA or Retirement Plan Beneficiary

As previously stated, the individuals chosen as beneficiaries of the trust may be considered the designated beneficiaries of the IRA or plan provided you specify a trust as beneficiary and satisfy specific requirements. This is important because it usually enables you to give beneficiaries of individual trusts the same post-death options as if you had identified them directly as beneficiaries of the plan or IRA. If the IRA custodian or plan administrator allows it, these people will often be able to compute post-death distributions using the life expectancy technique, which might possibly stretch distributions over a number of years.

An extended post-death payout period extends tax-deferred growth in the IRA or plan and spreads out the income tax burden of the beneficiaries on the money. Naming a trust as the beneficiary of an IRA or plan will only restrict your possibilities for post-death distributions if you choose to support your surviving spouse. In this situation, naming your spouse directly as the beneficiary of an IRA or plan is usually preferable to establishing a trust with your spouse as the beneficiary for income tax planning purposes (though perhaps not for death tax planning purposes).

Caution: Should the life expectancy approach be employed, post-death payouts have to start on December 31 of the year after your passing and be determined by the oldest beneficiary of the trust's single life expectancy, or the beneficiary with the shortest life expectancy.

Caution: If the trust you have designated as IRA or plan beneficiary is not properly designed, you may be treated as if you died without a designated beneficiary. That would likely limit the payout period for post-death distributions, in many cases considerably.

The life expectancy technique may only be applied to decedents who pass away after 2019 provided that the selected beneficiary is qualified to receive benefits. An eligible designated beneficiary is a designated beneficiary who is not more than ten years younger than the IRA owner or plan participant (e.g., a close sibling), the spouse or minor child of the IRA owner or plan participant, or a person who is disabled or chronically ill. Certain trusts for beneficiaries who are incapacitated or have chronic illnesses are subject to special regulations.

Naming a Trust Can Allow You to Retain Control After Your Death

When you designate one or more individuals directly as beneficiaries of your IRA or retirement plan, after your death, those individuals are generally free to do with the inherited funds as they please. This could mean, among other things, withdrawing all of the funds in one lump sum and incurring a large income tax bill.

But if you create a trust for your chosen beneficiaries and name that trust as the beneficiary of your IRA or plan, you can keep some control over the money after you pass away. After you pass away, the monies in your IRA or plan will still go to your designated beneficiaries, but in accordance with the terms of your will as stated in the trust agreement. This often allows you to manage the timing and size of disbursements, keeping money from being wasted by your kids or other beneficiaries of the trust.

Caution: In certain situations, the trade-off for obtaining tax benefits can include having to adhere to IRS distribution regulations rather than creating your own distribution plans from scratch for your trust. Furthermore, income that is held in a trust and not distributed to beneficiaries can be subject to high income tax rates.

Assets Held in a Trust May Be Protected from Creditors

For the duration that the funds stay in the trust, IRA or retirement plan assets left to a well-drafted trust for the benefit of your designated beneficiaries may experience significant protection from creditors. In actuality, giving your beneficiaries access to retirement assets through a trust will frequently offer them more creditor protection than giving them directly to your beneficiaries. If you have considerable unsecured debts for one or more of your beneficiaries, this could be a big benefit. To obtain more information and to determine which kind of trust will offer the greatest creditor protection, speak with an estate planning lawyer.

A QTIP Trust for Your Spouse May Be Beneficial

One sort of marriage trust that enables you to pay for your surviving spouse during their lifetime, delay estate tax upon your passing, and choose the eventual beneficiaries is a qualified terminable interest property (QTIP) trust. Your spouse will receive payments over their lifetime if you choose this kind of trust as the beneficiary of some or all of your retirement assets. If the entire account is not depleted, any remaining funds may be bequeathed to your children or other beneficiaries. Assets from your retirement plan that are placed in this kind of trust are not liable to estate tax when you pass away, but your spouse's taxable estate will contain the remaining assets. Contact an estate planning lawyer for further information.

Caution: A U.S. citizen spouse is required to use a QTIP. A qualified domestic trust (QDOT), a unique kind of trust, can be suitable if your spouse is not a citizen of the United States. Similar to a QTIP, all trust income is given to your surviving spouse while they are living. This is also the case with a QDOT. The assets will be taxed in the first spouse's estate at the death of the surviving spouse or upon the earlier withdrawal of principle, in contrast to a QTIP where residual trust assets are included in the surviving spouse's estate for estate tax purposes. Contact an estate planning lawyer for further information.

A Credit Shelter Trust May Be Beneficial

In certain situations, you might want to designate part or all of the assets in your retirement plan or IRA as the beneficiary of a certain type of estate-tax-saving trust. There are other names for this kind of trust, such as "exemption trust," "B trust," "credit shelter trust," and "bypass trust." Generally speaking, the trust's size is determined by the size of the applicable federal exclusion amount. This kind of trust usually serves the dual function of allowing your surviving spouse (or other beneficiaries) to profit from the assets placed in the trust and excluding those assets from estate tax upon your death. Contact an estate planning lawyer for further information.

Caution: Unless you add particular provisions to the trust deed, your surviving spouse may not receive enough support if all or most of your inheritance is placed into this form of trust under the rising applicable exclusion threshold.

Caution: You might not want to reduce the value of this kind of trust by funding it with income-taxed retirement assets because it might be permanently exempt from estate tax. If feasible, other assets could serve as the trust's more suitable funding source.

Caution: For certain married couples, perhaps this is not the best course of action. The state death credit was replaced with a deduction beginning in 2005 by a tax law established in 2001. Consequently, a large number of states that levied a death tax equivalent to the credit separated their tax structures and implemented a separate death tax. A smaller exemption than the federal exemption is permitted in many of these states. Certain couples might be more susceptible to increased state death taxes as a result. For further information, speak with your financial advisor.

Tip: In 2011 and later years, the unused basic exclusion amount of a deceased spouse is portable and can be used by the surviving spouse. Portability of the exclusion may provide some protection against wasting of the exclusion of the first spouse to die and reduce the need for a credit shelter or bypass trust.

Disadvantages of Naming a Trust as Beneficiary

Naming a Trust for The Benefit of Your Spouse May Limit Post-Death Options

You can create a trust for your spouse's benefit and designate that trust as the beneficiary of your retirement account or IRA if you wish to support your spouse after your death. If all of the aforementioned conditions are satisfied, your spouse, as the trust's beneficiary, may then be recognized as an authorized beneficiary of the IRA or plan. Nevertheless, consider your options carefully and consult an expert before selecting this beneficiary. The use of a trust may restrict or eliminate some possibilities that your spouse might have if they were directly named as beneficiaries of the IRA or plan after your death.

For instance, even if your spouse were the only beneficiary of the trust, they would no longer be able to treat an inherited IRA as their own account due to the minimum needed distribution regulations. Generally speaking, the easiest approach to accomplish this goal is to name your spouse as the beneficiary of your IRA or plan assets directly, unless there are special circumstances that require the establishment of a trust. Making your spouse the principal beneficiary gives you the most freedom and options when it comes to post-death payout planning.

Caution: Nonspouse beneficiaries cannot roll over inherited funds to their own IRA or plan. However, a nonspouse beneficiary can make a direct rollover of certain death benefits from an employer-sponsored retirement plan to an inherited IRA (traditional or Roth).

Trusts Can Be Complicated and Costly to Set Up

Establishing a trust can be costly, and it can be laborious and difficult to maintain it year after year. Therefore, the benefits of employing a trust as an IRA or retirement plan beneficiary should be evaluated against the costs of setting up the trust and the work required to properly operate the trust. Furthermore keep in mind that you can be viewed as though you passed away without a chosen beneficiary for your IRA or plan if the trust is not correctly structured.

It would probably reduce the time frame within which mandatory post-death distributions must be made. The provisions of your trust should consider estate tax planning considerations and rules pertaining to the distribution of trust income. Additionally, the net amount actually in a trust that is exempt from death tax (such a credit shelter trust) is decreased when the trust is funded with assets that have an inherent income tax obligation.

Also, a trust might not be beneficial based on its goals and other elements. Using a trust for estate tax reasons may or may not make sense, depending on the size of your estate and the amount of the estate tax exemption in the year of your death. Seek advice from an estate planning lawyer for further information.

This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of  The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.

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