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Your Guide to Naming a Trust as an IRA Beneficiary - Werner

What to Know About Naming a Trust as an IRA Beneficiary

Troy Werner and his family

Written by Troy Werner

Troy Werner has been an indispensable asset to The Werner Law Firm since joining in 2009, providing exceptional legal service to its clients.

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POSTED ON: February 27, 2023

It is important to consider listing a trust as an IRA beneficiary when designating someone to receive the money in your IRA account after you pass away. The typical individual retirement account (IRA) is a tax-advantaged investment account that allows you to accumulate wealth without an income tax burden, typically as a (limited) portion of […]

It is important to consider listing a trust as an IRA beneficiary when designating someone to receive the money in your IRA account after you pass away. The typical individual retirement account (IRA) is a tax-advantaged investment account that allows you to accumulate wealth without an income tax burden, typically as a (limited) portion of your monthly income.

By selecting a trust as an IRA beneficiary, you can ensure that your hard-earned savings are distributed according to your wishes and used for the benefit of your loved ones. Review your beneficiary designation regularly to reflect your current wishes and circumstances.

Most IRAs are subject to required minimum distributions unless they are a Roth IRA – but depending on how much you invested (or aim to invest) over your working years, your IRA may represent a substantial portion of your estate in death. But did you know you can also name a trust as IRA beneficiary to inherit the remainder of your IRA? Should it remain when you die?

In fact, across the US workforce, IRAs collectively hold over $11 trillion in assets, representing about a third of all retirement assets in the country. That is a lot of money potentially passing to the next generation and the one after that.

However, you don’t need to name individuals when assigning beneficiaries to your IRA. You can also name legal entities, such as businesses or trusts. Naming a trust instead of your child or grandchild has its pros and cons – and depending on how your IRA was set up, it may be one of the best ways for you to preserve your wealth for future generations and bolster or kickstart the family fortune.

How Is an IRA Inherited?

It is truly little we can take to the grave, materially speaking. You could request to be buried in your car or invest in a mausoleum, but most people aim to pass on as much of what they had in life to those they love after death. An IRA is no different, except that IRAs usually do not go through a will or are often a matter of probate.

A will is the poster child of estate planning documents. Still, it cannot be used to designate an heir for assets with a designated beneficiary, including most retirement and investment accounts.

Most investors are asked to name primary and secondary beneficiaries when creating an IRA. When you die, should your IRA still have available funds left, the remainder will be sent to your named beneficiary (or beneficiaries) without the need for an extended probate investigation?

It’s a little different if a person dies without naming an heir to their IRA. At that point, its remainder may pass to the decedent’s estate, where it becomes subject to probate and the inheritance process.

Passing the remainder of your IRA to your children or grandchildren makes perfect sense. The money you do not need in life can help provide a significant windfall to your descendants at a tough time.

Tax Implications of Inheriting an IRA

Suppose you opted for a traditional tax-advantaged IRA. If you opt for a Roth IRA, your contributions to the account will be subject to income taxes throughout your life. In that case, your heirs will end up paying income taxes on the money they withdraw from the account and will be forced to make required minimum distributions (or face a hefty tax penalty from the IRS). Still, all distributions become tax-free in retirement (and death). The income can be drawn out over an extended period, allowing for a greater return on investment – no minimum distributions necessary.

But what if the person you want to leave the money to is a minor, and you pass away earlier than expected? What if you worry about your beneficiary’s ability to manage and invest their inheritance wisely? What if you have other concerns about the safety and protection of your assets as they pass into the hands of your loved ones?

For additional flexibility, safety, and control, some people leave the remainder of their IRA to a trust rather than a single person.

What is a Living Trust?

A trust is a legal agreement between its creator, surviving manager (trustee), and beneficiary or beneficiaries. As the name suggests, living trusts are created while the grantor is still alive and go into effect immediately.

When a trust is made, the assets funded into the trust are actively managed by the trustee until such a time that they can be distributed to the beneficiary.

Most grantors choose to be their managing trustee, naming a secondary (or successor) trustee to succeed them in death. This saves the additional expense of paying for managing the contents of a trust while still living.

Unlike a will, which represents a set of instructions, a trust must be actively managed until it is resolved. However, trusts have certain benefits which can make them superior to the alternative.

The human element is the first and foremost benefit – a living, breathing trustee with a fiduciary duty can manage the contents of a trust for years after the grantor’s death, paying out a small monthly income to the beneficiaries of the trust while investing and growing the value of the principal.

What Are the Downsides of Naming a Trust as an IRA Beneficiary?

A trust offers greater control and may offer additional asset protection over other arrangements depending on how it is written. But trusts do have potential flaws.

For one, stretch IRAs have been made more complex due to the SECURE Act, meaning an IRA must be entirely distributed among beneficiaries within ten years of the owner’s death. Furthermore, the required minimum distributions are calculated based on the eldest beneficiary’s life expectancy, which may hasten distribution and minimize the longevity of the IRA if there are multiple beneficiaries with varying ages.

Last but not least, trusts must be managed. This can be costly.

Always Consult a Professional

Working with a professional is important if you intend to make significant changes to your estate plan or begin creating one. The expertise of a legal professional goes a long way. The advice of one who has reviewed and considered your circumstances and situation is even more valuable.

While there are templates and DIY guides for nearly every step in the estate planning process, crude templates and nonspecific guides are no substitute for an individualized plan, especially when trusts are involved. Versatility and flexibility are a trust’s most significant strengths; you must know how and when to utilize them to take full advantage of them.

In matters of estate planning, even simple clerical errors can net a relative fortune of losses. Preempt mistakes by taking the path that ensures they aren’t issues to begin with.

What to Know About Naming a Trust as Beneficiary of IRA - Werner

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