How To Use A Trust to Achieve Maximum Tax Deferral ForIRA Distributions Over Multiple Beneficiaries’Life Expectancy
Whenever you deal with tax-favored accounts like IRAs, complex rules typically apply.The primary responsibility for planning what will happen to IRA assets after death lies with the original owner. The IRA owner has the power to name primary and contingent beneficiaries who will receive the assets after the owner’s death. If the IRA owner makes mistakes in naming beneficiaries, the results can be costly.
If IRA assets are left directly to beneficiaries, they often withdraw the full amount of the IRA immediately, incurring significant income taxliability in the process. Leaving IRA assets outright to minorswill require a court-supervised conservatorship, which is typically expensive and burdensome.
In order to avoid these scenarios, creating a trust for beneficiariesof all ages as the optimum solution. However, when IRA assets are involved, using a trust to hold an inherited IRAis tricky. You need to make sure the trust can take advantage of the same tax benefits available to individual beneficiaries.
Qualifying a trust for lifetime distributions
The key to maximizing the tax benefits of IRAs that name trusts as beneficiaries is to make sure that the trust includes the provisions necessary to treat the trust beneficiaries as designated IRA beneficiaries for tax purposes. The trust must give the trustee power to follow IRS rules for making minimum distributions. The trust must be irrevocable after the IRA owner’s death and specific trust beneficiaries must be identified in the trust document. The trustee must give basic trust information to the financial institution administering the IRA, including a list of trust beneficiaries and the language of the trust itself, including any amendments.
In determining the appropriate life expectancy over which distributions from the IRA must be made, the age of the oldest trust beneficiary must be used. If there aretwo or more beneficiaries, such as children, but just one trust will hold all the IRA assets, all of the beneficiariesmust take distributions using the life expectancy of the oldest beneficiary. But by creating separate trusts for each beneficiary, naming each trust as an equal share beneficiary of the IRA, then the beneficiaries (or any beneficiary) can each use his/her own age,which will determine the rate at which each must take IRA distributions. Separating trusts can extend the life of an IRA by almost the same amount of time as the difference in age among beneficiaries. In cases involving beneficiaries of widely disparate ages, this can be quite valuable.
Although the trust can limit distributions of principal, to ensure that you follow IRS rules be sure the trust includes provisions that make the trust a so-called conduit trust. This means that the trust must not accumulate income, but rather must distribute any income to the trust beneficiary. For practical purposes, if the trust’s only assets are interests in inherited IRA accounts, make sure that the trust will distribute the amount of the annual required minimum distributions from the IRA to the trust beneficiaries outright. Although this sometimes runs counter to the wishes of the original IRA owner, required minimum distributions for young beneficiaries are generally so small — between 1% and 2% for beneficiaries under 30 — that the benefits from tax deferral outweigh the risk of indiscriminate spending of the distributed money.
Using other types of trusts as IRA beneficiaries
In order to meet all of the rules involved with trusts that are IRA beneficiaries, it’s generally best to draft a separate trust that will only hold the IRA. However, there are situations in which IRA owners will wish to use other types of trusts, such as marital trusts or bypass trusts. Here, the need to meet not only the IRA-related trust rules, but also the rules relating to the marital or bypass trust itself, makes planning especially complicated.
Protecting assets for beneficiaries achieving getting long-term tax deferral can be extremely useful for IRA planning. Knowing and following the rules can make the difference between large tax savings and a huge tax bill for your loved ones