You cannot put your individual retirement account (IRA) in a trust while you are living. You can, however, name a trust as the beneficiary of your IRA and dictate how the assets are to be handled after your death. This applies to all types of IRAs, including traditional, Roth, SEP, and SIMPLE IRAs. If you establish a trust as part of your estate plan and want to include your IRA assets, it is important to consider the characteristics of an IRA and the tax consequences associated with certain transactions.
Key Takeaways
- You cannot put your individual retirement account (IRA) in a trust while you are living.
- You can state a trust beneficiary of your IRA and dictate how the assets are to be handled after your death.
- The steps taken regarding the treatment of an IRA can significantly affect how the amount is taxed.
- Trust beneficiaries rarely benefit from tax savings.
What Is an IRA?
IRAs were created in 1974 under the Employee Retirement Income Security Act, or ERISA, to help workers save for retirement on their own. At the time, many employers could not afford to offer traditional-style pension plans, leaving employees with only Social Security benefits after they stopped working.
The new IRA accounts achieved two goals. First, they provided tax-deferred retirement savings for those not covered under an employer-sponsored plan. Second, for those who were covered, IRAs provideda place for retirement-plan assets to continue to grow when and if the account holder changed jobs via an IRA rollover.
Who Can Own an IRA?
As the name implies, individual retirement accounts can only be owned by an individual. They cannot be held jointly, nor can they be conducted by an entity, such as a trust or small business. Additionally, contributions can only be made if certain criteria are met. For example, the owner must have taxable earned income to support the contributions. A non-working spouse can also own an IRA but must receive contributions from the working spouse, and the working spouse's income must meet the criteria.
Regardless of where the contributions originate, the IRA owner must remain constant. Only certain ownership transfers are allowed to avoid being categorized as a taxable distribution. If transferred to a trust, IRA assets become taxable as this transfer is seen as a distribution by the IRS. In addition, if the owner is under age 59½ at the time of distribution, an early withdrawal penalty is imposed. The trust can accept IRA assets of a deceased owner, however, and establish an inherited IRA.
Advantages of a Trust Beneficiary
Naming a trust as the beneficiary to an IRA can be advantageous because owners can dictate how beneficiaries use their savings. A trust instrument can be designed in such a way that special provisions for inheritance apply to specific beneficiaries—a helpful option if beneficiaries vary greatly in age, or if some of them have special needs to be addressed. Many people also believe the trust provides tax savings for beneficiaries, but that is rarely the case.
Important factors to consider are how beneficiaries take possession of the IRA assets and over what time period. Seek advice from a trust adviser well-versed in inherited IRAs. To gain the maximum stretch option for the distribution of the account, the trust must have specific terms such as "pass-through" and "designated beneficiary." If a trust does not contain provisions for inheriting an IRA, it should be rewritten, or individuals should be named as beneficiaries instead.
Disadvantages of a Trust Beneficiary
Although moving all assets into the name of a trust and designating it as the beneficiary on retirement accounts is commonplace, it is not always a good decision. Trusts, similar to other non-individuals that inherit IRA assets, are subject to accelerated withdrawal requirements, most often within five years from the original IRA owner's death.
If the "pass-through" trust rules are applied by the IRS, the IRA assets must be withdrawn within a 10-year period. (An exception is made if the trust beneficiary is an eligible designated beneficiary. An eligible designated beneficiary includes a surviving spouse, a disabled individual, a chronically ill individual, a minor child, or an individual who is not more than 10 years younger than the account owner.) If the "pass-through" trust rules do not apply, the IRA assets will need to be withdrawn within a 5-year period.
Depending on the size of the account, this could place a burden on beneficiaries. Particularly detrimental is eliminating the spousal inheritance provisions by naming a trust instead of a spouse as the beneficiary.
While trusts can streamline most estate-planning areas, they can create more paperwork and even additional tax burdens for beneficiaries of an inherited IRA. Work closely with an estate planner, attorney, and accountant, who are all knowledgeable about trusts and IRAs, to maximize a legacy.
I'm well-versed in individual retirement accounts (IRAs) and their integration with trusts. The relationship between IRAs and trusts is crucial for estate planning, taxation, and asset distribution post the account holder's demise. Here's a breakdown of the concepts mentioned in the article:
1. IRAs and Trusts
- Ownership Limitations: An IRA cannot be owned by a trust during the account holder's lifetime.
- Beneficiary Designation: However, a trust can be named as an IRA beneficiary, allowing the account holder to control asset distribution posthumously.
- Tax Implications: Properly structuring trust beneficiaries for IRAs is vital as it significantly affects taxation upon distribution.
2. What Is an IRA?
- Purpose: Established in 1974 under ERISA to aid individuals in saving for retirement.
- Tax Benefits: Provided tax-deferred savings for those without employer-sponsored plans and facilitated rollovers for those changing jobs.
3. Ownership Criteria
- Individual Ownership: IRAs can solely be owned by individuals, not jointly or by entities like trusts or businesses.
- Contribution Eligibility: Contributions are tied to specific criteria like taxable earned income. Non-working spouses can have IRAs but need contributions from working spouses meeting eligibility.
4. Advantages of a Trust Beneficiary
- Control and Special Provisions: Trusts allow for specific directives for beneficiaries based on age, needs, or circ*mstances.
- Tax Considerations: Contrary to popular belief, trusts rarely offer tax savings for IRA beneficiaries.
5. Disadvantages of a Trust Beneficiary
- Withdrawal Requirements: Trusts inheriting IRA assets may face accelerated withdrawal demands within a limited timeframe.
- Tax and Administrative Challenges: Trusts can create additional paperwork and tax burdens for beneficiaries, especially regarding inherited IRAs.
Navigating the complexities of integrating trusts with IRAs demands careful consideration of tax implications, withdrawal requirements, and ensuring that the trust structure aligns with maximizing benefits for beneficiaries while avoiding potential pitfalls.
Understanding these intricacies allows for informed decision-making in estate planning, making it essential to collaborate with professionals well-versed in both trusts and IRAs, including estate planners, attorneys, and accountants.
