October 1, 2005

Trust as the IRA Beneficiary

Houston Tax Attorney Blog

Houston Tax Attorney

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I continue to hear a number of financial planners, accountants and even attorneys say, “Don’t name a trust as the beneficiary of an IRA. ” The rationale is that naming individuals as the IRA beneficiary is preferable because the individual can take the IRA distributions over the course of the beneficiaries lifetime; whereas, a trust named as a beneficiary would require the beneficiary to take a lump sum distribution within five years of the IRA holders death. That was once true; however, the Treasury Regulations have since been amended, as evidenced by private letter ruling 2005-37-7044.

This ruling describes a “required minimum distribution conduit trust ” (RMD trust). RMD trust rules are somewhat involved, but essentially RMD trusts allow IRA proceeds to be held in trust for individual beneficiaries and the IRA funds can be maintained in trust for and paid out over the course of the beneficiaries lifetime. In general, these trusts involve two issues: (1) whose life expectancy IRA distributions are based on and (2) how the life expectancy is calculated when there are multiple beneficiaries.

The Treasury Regulations provide that the life expectancy of IRA distributions is based upon the beneficiary’s life expectancy. If there are multiple trust beneficiaries then the life expectancy is that of the oldest beneficiary. This can be disadvantageous for younger beneficiaries when there are also older trust beneficiaries (such as where a trust names the grandchildren and parents as beneficiaries). The Regulations and letter ruling address this inequity by providing that if the IRA proceeds are allocated to separate trusts with separate trust beneficiaries, the life expectancy for each individual beneficiary will be the life expectancy used for purposes of making distributions.

Skipping over the rest of the specifics, you might be wondering when these trusts might be useful or when they should be used. The short answer is that these trusts are useful when a significant portion of ones estate consists of an IRA (or IRAs), there are multiple beneficiaries who could benefit from stretching out IRA distributions for a long period of time, the beneficiaries will be likely to have taxable estates that are large enough to incur an estate tax liability, and/or one or more of the beneficiaries might have future creditor problems. In the later case, the trust can contain provisions granting the trustee the power to make distributions and a spendthrift provision. The net result is that IRAs can be stretched out for the maximum period allowed, income taxes are deferred for that period allowing maximum growth, the beneficiary does not increase their estate tax liability, and the IRA proceeds can continue to be a creditor-proof stream of income for beneficiaries.

RMD trusts are powerful estate planning tools. RDM trusts can solve a number of issues given the right circumstances. The bottom line: More advisers should be recommending RMD trusts, as opposed to saying that “trusts should not be named as IRA beneficiaries.”

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