Should You Create an IRA Trust?

If you’ve created a family trust you might be wondering if you should also create an IRA trust. In some cases, this can be a very clever move, but in other cases it could be a colossal error. Let me explain.

Background

The beautiful thing about retirement accounts is that they have some very powerful estate planning devices built into them. That’s because every retirement account allows you to name a beneficiary. So you don’t need to do much in order for your retirement accounts to pass to your beneficiary – just be sure to complete your IRA beneficiary form correctly.

If you do so, the money will go directly to that named beneficiary without any need for an attorney, court or probate upon your death. Sweet, fast, free. What’s not to love about those IRA beneficiary rules? Oh…and to make things even better, the beneficiaries receive your retirement account, make it their own and don’t have to pay taxes on most of the money.

If your spouse is the beneficiary of your retirement account, he can also move the money over to his retirement account tax-free. If he does so, he won’t be forced to take ANY RMD out of the account until he reaches age 70 ½. Of course he may take money out at any time if he so chooses. But he can continue to defer tax payments for many years.

If your beneficiaries are individuals other than your spouse, they can defer taxes for many years on much of the money but not all of it. The rules that govern this topic are called beneficiary IRA distribution rules. They state that the beneficiary must take out a tiny bit of this inherited retirement account, but not much. The amount is based on their age. So the younger the beneficiary is, the longer he can continue to grow most of the account. So far so good. But what happens if you have an IRA trust and use it as beneficiary?

The IRA Trust

If you name your family trust as the beneficiary, the money will probably have to be withdrawn within five years of your death. That means if you go this route, you forfeit your beneficiaries’ opportunity to continue to grow the money tax deferred. They’ll have to take all the money out of the tax deferred account over five years and pay all the tax on it.

If you amend your family trust to have special provisions or you set up a special IRA beneficiary trust, the beneficiaries won’t have to take out all the money within five years. In most cases, you can have these special provisions written into your trust when you set it up, at no extra cost. Just make sure to speak with your attorney about this before she drafts your trust. If you decide to set up a separate trust, that’s going to set you back a few shekels.

Are there other reasons to name an IRA trust beneficiary?

Yes. Doing so gives the person who set up the IRA much more control. If you name a beneficiary outright, that person has the right to take all the money out of the account as soon as you die. While it’s not a very smart thing to do, it’s always a possibility. Believe it or not, people do dumb things with money every now and then.

But with a trust, you don’t have to worry about that. Your trust controls when the beneficiary is allowed to withdraw money from the account.

At the end of the day, this is just a question of what your priorities are. If you think your beneficiaries are big spenders and you want to make sure they don’t do stupid things with your money, set up a trust. If you think they are responsible or you don’t care what they will do with the money, don’t worry about it.

Is it important to you to control what your beneficiaries do with your IRA once they inherit it? Why or why not?