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Designating a Trust as Retirement Beneficiary

Feb 02, 2018 | Peter Christensen |

Designating a Trust as Retirement Beneficiary

IRA owners may designate a trust as the beneficiary of their IRA. In general, this approach allows the owner to somewhat control how their assets are distributed upon death. In this article, we’ll discuss the steps an IRA owner needs to take to ensure the trust meets their wishes.

How a trust can be your beneficiary

If the beneficiary is a nonperson—in our case, a trust—the IRA owner is considered to have no beneficiary when determining the beneficiary’s life expectancy, which is used for calculating and distributing the required minimum distribution (RMD) amounts. In other words, the beneficiary cannot use the life expectancy method to calculate distributions. Instead, the beneficiary must distribute the assets within five years. Should the IRA owner die on or after the RBD, this period cannot extend past the remaining life expectancy of the owner.

There is a way to extend the RMD term following the death of an IRA owner by working under an exception in which allows the oldest remaining beneficiary of the trust to be considered the beneficiary of the IRA in terms of defining the distribution options.

For the exception to apply, the following requirements must be met:

  1. The trust is valid according to state law.
  2. The trust is irrevocable or will become irrevocable when the IRA owner dies.
  3. The trust’s beneficiaries can be identified.
  4. By Oct. 31 of the year following the death of the IRA owner, a copy of the trust documents are provided to the IRA custodian.

Why designating a trust as your beneficiary is a good idea

Below are some reasons why an IRA owner may want to designate a trust as their beneficiary.

  1. To be in control over the distribution of the IRA assets.
  2. To achieve spendthrift beneficiary protection. If the IRA owner suspects that a beneficiary will carelessly spend their inheritance, the owner can choose to disburse the assets over time instead of through a lump-sum payment. The owner can also choose that parts of the assets be earmarked for specific purposes, such as education. By designating a trust as the beneficiary, the owner ensures that the trust provisions are followed.
  3. To provide for children from a previous marriage. If the IRA owner wants to ensure that their spouse and their children from any previous marriage receive their share, the owner can designate a trust such as a qualified terminable interest property (QTIP) trust.

Possible problems when designating a trust as the beneficiary

While designating a trust may be for some be the right choice, the IRA owner needs to take certain steps to avoid that the designation leads to problems for the heirs. Always check with the IRA custodian that the provisions are acceptable and follow the regulations to avoid that the custodian deems them unacceptable or that they conflict with the IRA plan document.

Below are some potential problem areas:

  1. If a copy of the trust isn’t provided to the custodian by Oct. 31, as described above, the underlying beneficiary cannot use the life expectancy of the oldest beneficiary when calculating RMD amounts.
  2. The trust can disclaim the assets, which means that the assets would go to the other primary or contingent beneficiary, and that the provisions would no longer be applicable. However, the owner can include a disclaimer provision, which may direct that, in the event of a disclaim, the assets be distributed according to certain provisions.

Seek professional advice

Designating a trust as the beneficiary is only an effective tool for estate planning if it agrees with the regulations, and if all stakeholders agree on the interpretation of the provisions. Always seek advice from both an attorney and a tax professional to ensure this is the right approach for you, and that you set up the IRA that best suits your needs. Only then can you feel certain that your maximize your estate planning.