While you’re alive, you can’t put your individual retirement account (IRA) in a trust. You can, however, name a trust as the IRA’s beneficiary and direct how the assets are handled after your death. This is true for all IRAs, including regular, Roth, SEP, and SIMPLE IRAs. If you wish to place your IRA assets in a trust as part of your estate plan, you need think about the characteristics of an IRA and the tax implications of particular activities.
Can you put an IRA in a revocable trust?
A revocable trust’s terms can be changed. This gives the trust owner the ability to reclaim assets that have been assigned to the trust as well as modify beneficiaries. However, you can’t transfer an IRA to a trust because that would require the trust to become the IRA’s owner. You can only select a new IRA owner as part of a divorce settlement, according to the IRS. Natalie Choate, an estate planning attorney, cautions that moving assets to a trust will always result in immediate taxation. The IRS considers this a distribution of assets, and you’ll owe taxes based on the value of the assets. If you are under the age of 59 1/2, you may be subject to an additional 10% penalty.
Why put an IRA in a trust?
Many people who have sizable IRAs plan to leave them to their children or grandchildren. Their estate planning include measures that allow IRAs to multiply for as long as possible after they are inherited – potentially decades. This entails selecting the appropriate beneficiaries and ensuring that they are well-informed about their alternatives.
Beneficiaries, unfortunately, do not always follow the plan. Most of the time, people can’t wait to spend the IRA they inherited. Money is sometimes well spent. Other times, the funds are squandered. Ex-spouses or creditors of the heirs may receive an inherited IRA. Some beneficiaries mismanage their investments, causing them to lose the majority of their value.
Beneficiaries frequently do not realize that the money they withdraw is taxed as ordinary income until it is too late. The IRS receives a large portion of inherited IRAs as a result of the taxes.
These issues can be avoided by IRA owners who want their IRA surpluses to provide for their children’s or grandchildren’s retirement. Setting up an IRA trust is one option.
An IRA trust can be established either through a will or while the owner is still living. The IRA is identified as the trust’s beneficiary.
Required distributions from the IRA must be made after the owner’s death. The needed payouts are based on the life expectancy of the trust’s eldest beneficiary if the estate follows the rules. The distributions will be small if the beneficiary is young. They could even be smaller than the IRA’s annual income and gains, allowing the IRA to grow despite the distributions for years.
The benefit of an IRA trust is that the trustee, rather than the beneficiary, is in charge of the payouts. Of course, the trustee has the option to remove more than the statutory payout from the IRA at any time.
When the trust’s rules are followed, payouts to the beneficiary are made. The trustee has the option of either making the required distribution or making a greater one. A lesser distribution may be possible, but the IRS, as we’ll see momentarily, disagrees. Alternatively, the trustee could be given the authority to distribute whatever amount he sees fit each year.
The trustee is often instructed to pay the minimal dividends until the beneficiary reaches a specified age. The beneficiary is then given complete discretion over the distributions.
The IRS discourages the trustee from accumulating RMDs rather than distributing them to the beneficiary. The income that a trust does not deliver to its beneficiaries is taxed. The income tax bands for trusts are narrower. When income exceeds $10,050, they pay the highest rate of 35 percent in 2006. There may also be state income taxes to consider. If the trust accumulates a lot of revenue, it will be taxed quickly.
That is why, in most situations, the trustee should take the annual statutory minimum distribution from the IRA and pay it to the beneficiary.
If the owner is eligible, another option is to convert an ordinary IRA to a Roth IRA. After the Roth IRA is inherited, minimum distributions will still be required, but the Roth distributions will not be taxable income. (For further information on converting to a Roth IRA, see the November 2005 issue or the IRA Watch part of the web site Archive.)
Obviously, the trustee protects the beneficiary from squandering the assets. The IRA trust, on the other hand, provides a number of advantages.
The IRA investments will be managed by the trustee or another individual identified in the trustee agreement. The beneficiary’s capacity to deplete the IRA’s value through poor investments is reduced as a result.
To keep the mandatory distributions to a minimum, the trustee and estate administrator must file the necessary papers with the IRA custodian by Oct. 31 of the year after the IRA owner’s death. The trust is listed as the Designated Beneficiary on the application.
Failure to file the papers on time causes the IRA distributions to be considerably accelerated. The whole IRA must be distributed within five years if the original owner of the IRA had not previously initiated required minimum distributions. If RMDs have already begun, the distributions will continue according to the owner’s schedule. In either situation, the dividends are likely to be higher than if the Designated Beneficiary is a trust with a younger beneficiary.
Work with an experienced estate planner if you decide to name a trust as a beneficiary. To qualify as a Designated Beneficiary, a trust must meet certain requirements set forth by the IRS. If the conditions are not met, the mandatory distributions will be expedited.
The trust must be legally enforceable under state law; the IRA custodian must receive a copy of the trust agreement by the first required distribution date; the trust must be irrevocable or become irrevocable upon the death of the IRA owner; and all potential beneficiaries who could benefit from the IRA must be clearly identified from the trust document.
The final requirement is the most difficult. Some common trust language may be used to disqualify the trust. That is why you require the services of a knowledgeable estate planner.
Furthermore, according to an IRS private letter rule from 2003, a trust is ineligible unless all statutory distributions are paid through to the beneficiary each year. A private ruling is only applicable to the person to whom it was made, but it does provide insight into the IRS’s thinking. You’ll probably want the trust to mandate distribution of at least all RMDs until there are clearer rules.
In our December 2002 and November 2003 issues, we went over the specific regulations for trusts as IRA beneficiaries in further depth. The Estate Watch area of the website Archive contains these articles.
A trusteed IRA is an IRA trust that is a version of the IRA trust. The IRA custodian places the IRA in a special trust. Trusteeship IRAs are not available from all IRA custodians or trust businesses. Those who do provide it demand substantial setup and annual fees, making it only a realistic choice if the IRA is worth at least $500,000.
The trusteed IRA can provide further wealth protection, but it is more expensive and has less flexibility.
Another alternative is to withdraw funds from your IRA early, pay all taxes, and then place the funds in a regular trust. Alternatively, you can use the IRA to make charitable donations in your will and leave your other assets to your heirs.
Setting up a trust as an IRA beneficiary can help you get closer to your estate planning goals. It can help to ensure that the majority of your IRA assets are protected until your heirs are older, possibly until retirement. However, it is more expensive to set up and has additional drawbacks. Before making a decision, think about the drawbacks and alternatives.
Should retirement accounts be placed in a trust?
Only put your retirement savings in a living trust if you have a personal reason. Consider your arguments carefully because there are no additional tax benefits, only potential tax difficulties, from using a living trust for retirement accounts. For example, if you’re afraid that your spouse or children may face tax implications or that your retirement assets will be used prematurely, you should seek the advice of a qualified financial planner. This will shield your retirement savings from unnecessary taxation and allow you to disperse the balances of your retirement accounts according to your choices.
What happens if a trust inherits an IRA?
When a trust is specified as the beneficiary of an IRA, when the IRA owner dies, the trust receives the IRA. The IRA is then kept as a separate account and treated as a trust asset. The following are some compelling reasons to name a trust as an IRA beneficiary rather than an individual:
- Getting around the beneficiary’s ownership restrictions. Perhaps the intended beneficiary is a minor who is unable to own the IRA due to legal restrictions. Perhaps the IRA owner wishes to help a special needs individual who will lose government benefits if he or she owns assets in his or her own name. In both circumstances, naming a trust as the IRA beneficiary, which will then become the legal owner in place of the minor or special needs individual, could be a viable solution.
- Solving problems involving a second marriage or various types of family configurations. During the lifetime of his second husband, an IRA owner may desire to have RMDs benefit his second spouse, with the remainder of the IRA passing to his own children. If an IRA owner leaves his IRA to his spouse outright, he can be sure that his spouse would profit, but he can’t be sure that his children will. His objective to help both sets of beneficiaries can be realized if he instead leaves the IRA to a properly formed trust.
- Putting a stop to a beneficiary’s access. We commonly think of IRA beneficiaries taking only the necessary minimum distributions, but an individual who inherits an IRA has the option of taking bigger distributions or even withdrawing the whole account balance. The access of a beneficiary of an inherited IRA owned by a trust, on the other hand, will be limited by the trust’s conditions.
- The process of naming subsequent beneficiaries. When an individual inherits an IRA, she has the option of naming her own initial successor beneficiaries. If the IRA owner wants to have more control over the successor beneficiary than the initial beneficiary, the succession provisions must be written in a trust and the trust must be named as the IRA beneficiary.
- Creditor protection is provided. A person’s personal IRA is protected from creditors to some extent, but this does not always apply to an inherited IRA. In Clark v. Rameker (2014), the United States Supreme Court held that inherited IRAs are not immune from creditors’ claims as “retirement funds” under the Federal Bankruptcy Code. An inherited IRA held in a properly constituted trust will not be a beneficiary’s asset and will have some creditor protection.
- Providing funding for estate plans that are geared to avoid estate taxes. The majority of rich persons’ estate plans incorporate trusts designed to reduce and defer the payment of federal and state estate taxes. The component of these trusts that shelters an individual’s federal or state estate tax exemption levels must be financed at the individual’s death for such estate plans to work as intended. An IRA is frequently the sole asset accessible for this purpose.
How is an IRA taxed in a trust?
“The income from the IRA is taxed at the recipient’s individual income tax rate because it is given to the trust beneficiary.” ” The trust will be taxed at the trust’s tax rate on income accumulated in the trust.
Can a trust transfer an IRA to a trust beneficiary?
I get this question at least once a week: “I’m working with a trust that manages an IRA that was passed down to me. “Can the trustee distribute that IRA to the trust’s individual beneficiaries?” The question’s unstated component is, “….without triggering a tax on your earnings?”
In most situations, a trustee can transfer an inherited IRA out of the trust to the trust beneficiary or beneficiaries without incurring any negative tax repercussions. Of course, that simple response is surrounded by many conditions, constraints, ifs, ands, and buts.
Should I put my house in a trust?
The opportunity to avoid probate is the principal advantage of putting your house into a trust. The probate process is public information, but the transfer of a trust from a grantor to a beneficiary is not. You can also bypass the multistate probate process by putting your house in a trust.
Can a trust be a beneficiary of a trust?
Anthea Stephens, a Senior Associate in Cape Town, talks about whether a trust can be a beneficiary of another trust. Without Prejudice, an attorney’s publication, originally published this piece.
The practice of treating a trust as a person has evolved in the drafting of deeds, wills, and conveyancing documentation. The question of whether or not this is correct in law raises a slew of additional issues that must be addressed before we can get to a judgment. First, who is eligible to be a trust beneficiary, and what are the qualities that a trust beneficiary must possess? To address this, we first look at the basic factors that must be present in order for a genuine trust to be established. Because of the legal implications that may arise from the type of a transaction in which property is received or disposed of, it is critical to understand and apply the trust form effectively.
The certainty of objects is one of the most important components in the establishment of a valid trust. Beneficiaries are referred to as “objects” in this context. In order to have assurance of “objective,” a trust other than a charity trust must have a person as a beneficiary. This is supported by the Trust Property Control Act 57 of 1988, which defines a trust as a “arrangement in which one person’s ownership in property is by virtue of a trust instrument made over or bequeathed… to the beneficiaries designated in the trust instrument, which property is placed under the control of another person, the trustee, to be administered or disposed of according to the provisions of the trust instrument for the benefit of the person or persons named in the trust instrument.”
It is crucial to understand the nature of a trust in order to determine if it could be a beneficiary.
A trust is a legal arrangement in which someone (a person or persons, juristic or not) holds or administers property for the benefit of another person or persons, the beneficiaries, or for the advancement of a charitable or other purpose.
A trust does not have its own legal personality.
Although a trust is included in the Income Tax Act 58 of 1962’s definition of a person, this only gives it legal personality for the purposes of this Act.
A trust does not have a separate legal identity unless it is defined by statute.
The South African courts have added to the confusion. Crookes v Watson established the inter vivos trust legal principles in South African law. An inter vivos trust is a contract between the founder and the trustee in favor of the beneficiary, also known as a stipulatio alteri or contract in favor of a third person, according to the Appellate Division in this case. Despite widespread criticism, this judgment is widely acknowledged as the present legal position in South Africa. The trustees’ fiduciary obligation was reduced to a contractual connection between the trustees and the possible beneficiaries by the court in this instance. The issue revolved around the relationship between trustees and beneficiaries, and a side effect of the decision was the trust form being crammed into a mold that was not appropriately shaped for it.
In the case of Braun v Blann & Botha, Corbett took the first step toward emphasizing the distinctiveness of a trust as something different. In this ruling, he declared a trust to be a one-of-a-kind legal entity that is separate from all other legal entities in South Africa. Despite the fact that this decision was taken in the context of testamentary trusts, it provided a ray of hope for the recognition of the trust form as a distinct entity. We’re still waiting for a proper classification thirty-five years later. Whatever the case may be, a trust is not a person in any sense.
Any trust in which one or more of the beneficiaries is a beneficiary is frequently included as a beneficiary in trust deeds.
Because a trust is not a person, this is not conceivable.
A trust that was founded solely to benefit another trust and in which the beneficiary was defined as a trust would thus be missing one of the necessary requirements of a trust, namely certainty of the trust’s object, namely the beneficiaries. Without a valid beneficiary, a trust cannot be established.
The trust would still be legitimate if there were other stated beneficiaries (provided the other essential elements were in place).
However, one would not be permitted to make distributions to a trust that is named as a beneficiary in a trust deed strictly speaking.
A “pour-over” clause would need to be incorporated in the trust deed for a trust to make a “distribution” of its assets to another trust. This clause would provide trustees the authority to transfer trust assets to another trust, typically one in which at least one of the original trust’s beneficiaries is also a beneficiary of the new trust. It’s worth noting that, in the absence of such a carefully worded power of appointment, a trustee can’t just assign trust property to another trust listed as a “beneficiary” of the trust.
Similarly, and perhaps more critically, when assets are donated to a testamentary or existing inter vivos trust under a will, the bequest must be made to the trustees in their capacity as trustees, not to the trust.
If a bequest to a trust (rather than the trustees) is contested, it may be determined to be invalid.
In the event that this condition arises, and there are no other stated beneficiaries, the estate will pass to the intestate heirs.
While it is likely that a court will do everything possible to carry out the wishes of the testator of a will or the settlor of a trust, it is not worth the risk. It’s all in the drafting, and “all” may very well refer to one’s entire inheritance in this scenario!
What do you do with an inherited IRA from a parent?
Many people believe that they can roll over an inherited IRA into their own. You cannot roll an IRA into your own IRA or treat it as your own if you inherit one from a parent, aunt, uncle, sibling, or acquaintance. Instead, you’ll have to put your share of the assets into a new IRA that’s been established up and properly labeled as an inherited IRA for example, (name of dead owner) for the benefit of (name of deceased owner) (your name).
If your mother’s IRA account has more than one beneficiary, money can be divided into separate accounts for each. When you split an account, each beneficiary can treat their inherited half as if they were the only one.
An inherited IRA can be set up with almost any bank or brokerage firm. The simplest choice, though, is to open your inherited IRA with the same business that handled your mother’s account.
Most (but not all) IRA beneficiaries must drain an inherited IRA within 10 years of the account owner’s death, thanks to the Secure Act, which was signed into law in December 2019. If the owner died after December 31, 2019, this rule applies to inherited IRAs.