Naming a Trust as Beneficiary of an IRA

As the baby boomers get older, and we continue to hear the oft repeated saying,

We are about to experience the greatest transfer of wealth in history

One of my planners recently asked my opinion about a situation – his client, a concerned parent, is about to retire and has approximately $2,500,000 in qualified money (IRAs/401(k)s, etc) and wanted to know his planning options to protect this money incase he untimely dies, i.e. before it is exhuasted.

Question Number 1 – Why do it?
Basic spend thrift protection!  If your beneficiary doesn’t own the IRA, outright, then you have effectively put “controls” on the money even though you have died.  How much control will be discussed later.

If you leave a beneficiary your IRA, outright, then there is nothing stopping that person from burying you and then cashing out the entire account.  Most people aren’t aware that they do not have to stretch it over their lifetime, nor are most people aware if your estate is named as a beneficiary of your retirement account, a stretch is not possible!

Put more succiently, if the beneficary can’t invade the retirement account without the Trustee’s Approval (Trustee = gatekeeper who you initially choose) then they can’t waste it!

Additionally, there are more advanced reasons of doing this facet of planning associated with bankruptcy law, but that is beyond the scope of this blog (there have been 6 cases in 6 different states that have invaded an inherited IRA!).

Question Number 2 – How do you do it?
There are 2 main types:

1)  Conduit (i.e. see through)

When the beneficiary is a conduit trust then the annual Required Minimum Distributions (RMDs) also known as Minimum Required Distributions (MRD) (I will do a whole post on RMDs) – that get paid to the trust are distributed right out to the trust beneficiaries and the trust beneficiaries pay tax at their personal income tax rates on the RMD amount.   The benefit - Beneficiary can’t get to corpus without gatekeeper’s approval

2) Discretionary a/k/a Accumulation Trust

RMDs are paid to the trust from the inherited IRA then trustee decides whether the money will remain in the trust or be paid out to the trust beneficiaries.  Any funds not paid out to the beneficiary are accumulated in the trust and that income is taxed at trust income tax rates (compressed). Beneficiary can’t get to income or corpus without gatekeeper’s approval.

Question Number 3 - What are the logistics to get this done?

First step is talking to an attorney and financial professional.  You need this document drafted by a professional.  Regardless of which one you choose the trust needs to ‘qualify’ to obtain stretch distributions:

4 Requirements

• Trust must be valid under state law
• Trust but be irrevocable or become irrevocable at the death of the owner
• Trust beneficiaries must be identifiable
• Trustee of the trust must provide a copy of the trust or a list of the trust beneficiaries and their entitlements to the custodian or plan administrator by Oct 31 of the year after the owner’s death
  • This factor is most often missed because the trustee is usually a layperson

Unwritten 5th element – Beneficiary must be an individual (or qualifying trust) or you will lose stretch, i.e. beneficiary can’t be an estate or corporation.

Second step is fixing your beneficiary designation

• Different IRA custodians will have different rules – Generally:
  • “X Irrevocable Trust Dated Y”
  • Z, as trustee for X Irrevocable Trust Dated Y
• Can even do it under testamentary trust – X Trust under Article V of Z’s Last Will and Testament etc.
• Different Trusts – % or absolute Dollars
• Sub Trusts

Questions? Comments?

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