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.
Should you put your 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 understand 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 named 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 unique 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 you put an IRA in a revocable trust?
Retirement accounts, such as your IRA, Roth IRA, 401K, 403b, 457, and the like, do not belong in your revocable trust. Placing any of these assets in your trust entails removing them from your name and renaming them in your trust’s name. The tax consequences can be devastating.
Beneficiaries are nearly always named on retirement funds. After consulting with an estate planning expert, you can name your trust as a beneficiary on retirement funds. If done incorrectly, this can result in an undesirable tax outcome.
Also, double-check that the custodian, or financial institution(s) where your retirement accounts are maintained, has beneficiaries identified. Make sure the language of your trust is up to date to reflect your current wants and aspirations.
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.
Should retirement accounts be 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.
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.
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.
Should I put my bank accounts in my trust?
Putting a bank account into a trust is a prudent move that will save your family the trouble of having to run the account in a probate case. It will also provide your replacement trustee access to the account if you become incapacitated.
Is it a good idea to put your house in a trust?
The opportunity to avoid probate is the principal advantage of putting your house into a trust. Putting your house in a trust also keeps some of your estate’s information hidden. The probate process is public information, but the transfer of a trust from a grantor to a beneficiary is not.
What is the downside of a living trust?
While there are many advantages to creating a revocable living trust, there are also drawbacks to consider. To begin with, revocable living trusts are more expensive to set up than traditional wills. However, if you’re ready to cope with the initial outlay, you might be able to save money in the long term by avoiding probate.
Another disadvantage of living trusts is that asset transfers can be time-consuming and complex. If you have a variety of assets, you’ll need to contact your various banks and agents to have everything transferred a procedure that could take a long time and a lot of paperwork.
A living trust does not, however, eliminate the necessity for a will. The majority of persons who create living trusts fail to transfer all of their assets. If you have assets that aren’t covered by your trust, you’ll need a will to direct how they are dispersed after you pass away. Furthermore, you can’t appoint guardians for your children with a living trust; you’ll need a will for that.
Who pays taxes on an IRA in a trust?
IRA distributions are taxed to the trust since they are deemed taxable income. With only $12,400 in taxable income, trusts can pay a maximum tax rate of 39.6 percent. If the trust distributes any of its revenue, however, such income is taxed straight to the trust’s beneficiary.