Dear Hayek,
I am reconsidering who I should make the beneficiary for my IRA. I heard that there are some advantages to naming a trust instead of an individual. Is this true, and if so, why?
Thanks for your help!
Benny Fishiary
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Dear Benny,
This is a very complex area of the law, and is also rapidly changing because of the 2020 passage of the SECURE Act and the recently published proposed regulations by the IRS dealing with the SECURE Act. Sometimes naming an individual as beneficiary of an IRA may potentially yield a better tax result, especially if that individual is a spouse, as a spouse can generally roll over an IRA into the spouse’s own IRA and delay taking required minimum distributions, depending on the age of the spouse.
However, for individuals who don’t have a spouse, or plan to name children or other individual as beneficiaries, there are some good reasons why you should consider naming a trust as an IRA beneficiary instead of an individual. Here are some of those reasons:
You can work around beneficiary ownership limitations: What if the intended beneficiary is a minor who is legally unable to own the IRA, or as the IRA owner, you want to support an individual with special needs? What if the special needs person will lose access to government benefits if he or she owns assets in his or her own name? A wise solution in both cases could be to name a trust as the IRA beneficiary, which will then become the legal owner in place of the minor or individual with special needs. There are also potential tax benefits to leaving an IRA to a minor or do a trust for an individual with special needs, as in both situations they can potentially benefit tax-wise from a longer stretch out of required distributions.
Protection from creditors: When you own an IRA, it generally offers no protection from creditors (as opposed to 401(k) plans and other ERISA plans, which do offer some asset protection against creditors). But an inherited IRA held in a properly-structured trust will not be an asset of the beneficiary and will therefore enjoy protection from creditors of the beneficiary.
You can be the one to name successive beneficiaries: If an IRA owner wishes to control multiple levels of successor beneficiaries beyond the initial beneficiary, the owner needs to set forth the succession terms in a trust and name the trust as the IRA beneficiary.
You can ensure that your children from a prior marriage are taken care of: An IRA owner who has been married more than once and has children from a prior marriage often wishes for RMDs to benefit the spouse during the spouse’s lifetime, and then have the remainder of the IRA, upon the death of the spouse, pass to the children from the prior marriage. If the IRA owner leaves the IRA outright to the spouse, there is obviously no guarantee that the children will receive anything.
You can limit a beneficiary’s access: We often think of IRA beneficiaries as taking only the required minimum distributions. However, an individual who has inherited an IRA has the right to take larger distributions, or even withdraw the entire balance of the IRA. The access of a beneficiary of an inherited IRA owned by a trust is subject to the terms of the trust, so the creator of the trust can limit the beneficiary’s lifetime rights to access funds inside the IRA. This can be especially important if the owner of the IRA has a child with a drinking problem, a substance abuse problem, or a gambling problem, or simply is not good holding onto money.
As you can see, there are many potential benefits to naming a trust as an IRA beneficiary, but it is not always the right solution for all people in all situations. No estate planning tool is the right solution for all people in all situations. That’s why almost everybody should have customized estate planning done by an experienced estate planning attorney. If you do not have your estate planning in order or would like to make updates, the Farr Law Firm is here to guide you.
Hope this is helpful,
Hayek
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