Trusts are often used as effective estate-planning tools. Individual Retirement Accounts (IRA) are a common way for investors to save money for retirement. These accounts help the investor earn tax-free gains, until the funds are distributed. Putting an IRA in a trust can help reduce taxes, but the trust must be carefully planned and worded.
Creating a Trust
Many investors who are planning their estates opt to fund a trust with an IRA, among other investments. There are many different types of trusts, and each have separate and distinct consequences. For example, a revocable trust can be changed, while an irrevocable trust can't. Some trusts, such as an AB trust, help large estates avoid estate taxes, while other trusts, like the popular revocable living trust, do not. Regardless of where you put your trust, its distributions are taxable income. But the type of trust you choose, and who your beneficiary, is makes a big difference.
If you transfer the proceeds of your IRA to a trust, it's considered a distribution and is taxable. Although it may be possible to transfer an IRA without triggering a tax, the IRS has never officially approved the technique, and your own personal situation may require an IRS ruling, which can be costly. A better way is making the trust the beneficiary of your IRA, because it's subject to deferred -- and possibly lower -- taxation.
The Life Expectancy Rule
After you pass away, your beneficiary -- or your trust's beneficiary or beneficiaries -- must take distributions, even if the beneficiaries aren't yet age 59 1/2. For a trust to qualify as a valid beneficiary of an IRA, it must met certain IRS rules. It must be valid under your state's law, it must be irrevocable after the grantor's death, the trust's beneficiaries must be identifiable, and a copy of the trust document must be given to your plan custodian by October 31 of the year following the grantor's death. If the trust isn't valid, then the beneficiaries may be forced to take annual distributions that are less tax advantageous. Valid trust distributions are taxable at ordinary rates, they can prevent the trust beneficiary's from squandering the IRA's assets.
The Marital Transfer
While trusts can be advantageous for beneficiaries, such as minor children or adults with special needs, leaving your IRA in a trust for your spouse can be risky. Because trusts with multiple beneficiaries must use the eldest beneficiary's age for the life expectancy requirement, your spouse's age might force the trust to take more in distributions than would otherwise be necessary. If you leave the IRA to your spouse directly, she may be able to roll that into her own IRA without consequence, thereby deferring both distributions and taxes.
- The Wall Street Journal; Trust as Beneficiary of IRA Is a Popular Strategy; Kelly Greene; Aug. 29, 2009
- UncleFed's Tax Board; Income and Estate Tax Planning for a Large IRA; October 1998
- UncleFed's Tax Board; IRS Proposes Revised IRA Distribution Rules; February 2001
- Retirement Income: IRA and Related Retirement Plans
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