Trusts can be useful for a variety of estate-planning goals, from providing control of when and to whom assets are distributed, to helping manage assets for minor children and passing on assets tax-efficiently.
For many investors, IRAs represent a significant portion of their retirement savings and overall net worth. But unlike other assets you might own, such as real estate or brokerage accounts, your IRA can’t go into a trust during your lifetime—and while you can arrange for your IRA to pass to a trust after your death, the tax regulations regarding retirement accounts following the owner’s death make it a complex decision. “Whether you should leave an IRA to a trust is far more nuanced than a simple yes or no,” explains Catherine Neijstrom, Fidelity Investments vice president, financial and trust planning lead.
Can you put an IRA in a trust?
During your lifetime, your IRA can’t go into a trust. The reason: Assets that are included in a trust, such as brokerage accounts or real estate, must be re-titled in the name of the trust. However, under the Internal Revenue Code, an IRA must be owned by an individual person or that individual’s beneficiaries (hence the “individual” in individual retirement account). Moreover, the tax benefits associated with IRAs depend on maintaining the account as a retirement vehicle owned by the account holder.
Can your trust be the beneficiary of your IRA?
Yes. While you cannot transfer the ownership of your IRA to a trust during your life, you can name a trust as the beneficiary at your death on your IRA beneficiary designation form.
When you die, the assets in the IRA pass directly to the beneficiary. If that beneficiary is a trust, the IRA proceeds will be paid into the trust and administered according to the trust's terms.
Advantages of naming a trust as an IRA beneficiary
Naming a trust as the beneficiary of an IRA can provide helpful control over how the IRA retirement assets are distributed and protected. However, it’s not something to do casually. “If you want to name a trust as beneficiary of your IRA, it’s important that the trust is drafted by a qualified estate-planning attorney specifically to receive retirement account assets, and that you understand the resulting tax implications,” says Neijstrom.
Disadvantages of naming a trust as an IRA beneficiary
Under current rules, naming a trust as the beneficiary of an IRA can accelerate taxation or increase the overall tax burden.
Assets withdrawn from a traditional IRA are taxable as ordinary income, and if the trust retains those distributions instead of passing them to beneficiaries, the trust may owe income tax.
Because of these complexities, consultation with both an estate-planning attorney and a tax professional is often helpful before naming a trust as an IRA beneficiary. “In general, if you are comfortable naming individuals or charitable entities outright as beneficiaries of your IRA, you should seriously consider that instead of leaving your IRA to a trust,” says Neijstrom.
Tax consequences of naming a trust as beneficiary of an IRA
The tax treatment of an IRA following the owner’s death is complicated and becomes even more so when a trust is involved.
Some individual beneficiaries of IRAs and some trusts for these beneficiaries’ benefit may be able to “stretch” distributions over periods based on the beneficiaries’ life expectancy. But in many cases a trust named as beneficiary must take full distribution of the IRA within a certain number of years of the original owner's death, potentially as few as 5 years, and often not more than 10. This rule applies to both traditional IRAs and Roth IRAs.
To qualify for a longer distribution period, a trust must be structured for "designated beneficiary trust” treatment. To qualify for designated beneficiary trust treatment, the trust must satisfy a number of rules. Among the most significant of these rules is that all the trust’s “countable beneficiaries” must be individuals. This can be problematic, in particular for clients who wish to include charities as trust beneficiaries.
Applicable tax rates are another consideration. Trust tax brackets are highly compressed compared with individual tax brackets, meaning trusts can reach the highest federal tax rates at relatively low income levels. “Even a properly structured designated beneficiary trust can have less-than-ideal tax consequences,” cautions Neijstrom.
Should you name a trust as your IRA beneficiary?
“Despite the complexities, there can be good reasons to leave an IRA to a trust,” Neijstrom says. She names several examples:
- Parents of young children. Minors generally cannot directly control inherited retirement assets, so a trust can be helpful to manage funds for the children until they are older.
- Disabled or chronically ill beneficiaries. In particular, beneficiaries receiving public benefits may not be able to inherit assets outright without jeopardizing those benefits. So it can be important to name trusts for such loved ones’ benefit as IRA beneficiaries rather than the loved ones outright.
- Beneficiaries who may struggle with managing money. If you are concerned that your intended beneficiaries may struggle to manage their inheritance appropriately due to substance abuse issues, limited financial skills, or other issues, the trustee of a trust can oversee distributions and help ensure the inherited assets are not quickly depleted.
- Beneficiaries who need creditor protection. Grantors who are concerned about intended beneficiaries’ creditor issues, including divorce risks, or about preserving wealth across generations sometimes use trusts to create additional layers of protection and control.
The bottom line
While you cannot place your IRA into a trust during your lifetime, you can name a trust as the beneficiary of your IRA after your death. Doing so may provide greater control over how retirement assets are distributed and protected, but it also introduces additional complexity and potential tax considerations. Because the stakes can be significant, it's wise to consult with both an estate-planning attorney and a tax professional if interested in naming a trust as an IRA beneficiary.