Naming a Trust as the Beneficiary of Tax Deferred Retirement Accounts
The beneficiary designations on your retirement accounts, such as individual retirement accounts (IRAs), 401Ks, or other tax-deferred retirement plans are among the most important decisions in your estate plan. There are circumstances in which it is advisable to name a trust as the beneficiary of a tax deferred retirement account. An IRA owner may choose to designate a trust as the beneficiary of the IRA in order to control the disposition of the assets after he or she dies. A trust may also be the best method to distribute assets to a beneficiary who has creditors or poor money management skills. The trust may protect the IRA assets from creditors and can protect the stretch-out quality of the IRA by preventing the beneficiary electing to distribute the IRA assets as a lump sum. The creditor protection will depend upon the circumstances, but use of the trust can further creditor protection. Another common reason for naming a trust as a beneficiary on an IRA is for minor children.
Designating a trust as the beneficiary of an IRA can be an effective estate planning tool. However, there are issues to consider and it is only effective if certain requirements are met. After the original IRA owner passes away there are required minimum distributions (RMDs) that must be taken by the beneficiary, forcing the account to be liquidated over time. However, the RMDs are able to be drawn out slowly over the life expectancy of the beneficiary. The question arises as to whose life expectancy is used when a trust is named as the beneficiary and the risk of potentially losing the ability to stretch the distributions after the death of the original owner. Fortunately, in certain circumstances a trust can be treated as eligible to stretch the post-death RMDs over life expectancy by looking through the trust to the underlying beneficiaries and using their life expectancies instead. This is considered a Asee-through@ trust and requires that the trust be drafted properly to be given such treatment.
In order to be treated as a Asee-through@ trust and qualify as a designated beneficiary, a trust must meet four very specific requirements as required by the Treasury Regulations:
1. Valid Under State Law. The trust must be valid under state law. This means that the trust must be properly signed and executed as a trust and does not contain any provisions that would invalidate the trust under state law. It is recommended that a trust be drafted by a competent attorney and then this first requirement should be a non-issue.
2. The Trust Must be Irrevocable. The trust must either be irrevocable, or will, by its terms, become irrevocable upon the death of the IRA owner. A revocable living trust that becomes irrevocable upon the death of the owner should qualify under this provision, as would any irrevocable trust that was drafted as irrevocable. A testamentary trust or other sub-trust that becomes irrevocable upon its formation should also qualify under this provision.
3. Trust Beneficiaries Must be Identifiable. The Treasury Regulations require that if distributions are going to be stretched over the life expectancy of trust beneficiaries, that the trust beneficiaries must be identifiable in the first place. This means that a beneficiary either be identified by name or as members of a class. For example, a trust with Amy children@ as the beneficiaries would be acceptable as the children can be identified. A further requirement is that an identified beneficiary be a Adesignated beneficiary,@ which means they must be an individual, living and breathing human being. If a charity or some other non-living entity is a trust beneficiary, then the trust would not be able to stretch the distributions over the life expectancy of the underlying beneficiaries because not all beneficiaries are designated beneficiaries. For example, if the trust listed Amy children and a charity@ as the beneficiaries the charity would preclude the trust from being able to stretch out the distributions.
4. Copy of Trust Document to Custodian. A copy of the trust documents must be provided to the IRA (or other tax deferred account) custodian by October 31 of the year immediately following the year in which the IRA owner died. It is best to determine with the IRA custodian what exactly it will require to meet this requirement.
If the four requirements above are met, then the trust as the IRA beneficiary can qualify as a designated beneficiary, and the post-death RMDs can be stretched. However, the stretch will be calculated based upon the life expectancy of the oldest trust beneficiary of the trust. For example, if a trust names a fifty year old, a forty year old, and a five year old as the beneficiaries, the RMDs will be distributed based upon the life expectancy of the fifty year old.
Designating a trust as the beneficiary of an IRA or other tax deferred retirement plan can be a complex process. It is recommended that you seek the assistance of a competent attorney and a tax professional to determine if and when a trust is appropriate, the type of trust that suits your needs, and to ensure that your estate planning needs are met and maximized.
This article is not intended to replace legal advice applicable to your situation and should be used only for informational purposes. Consult with your legal or tax advisors before implementing any suggestion contained herein.
Ms. Soyer is an associate attorney with the firm of Sandra L. Clapp & Associates, P.A. and can be reached at firstname.lastname@example.org or (208) 938-2660.