eBook EstatePlanning Book

Key Information About Beneficiary Trusts for IRA Accounts

1. What is a Beneficiary Trust for an IRA Account?

The IRA Beneficiary Trust is an estate planning vehicle designed to control the distribution of IRA assets after death. The IRA Beneficiary Protection Trust is a stand alone document that directs the beneficiary to the income tax-saving “stretch IRA” rules in an effort to preserve hard earned tax benefits and provide asset protection for the beneficiary.

2. What are the Benefits of Beneficiary Protection Trusts for IRA Accounts?

Normally, upon inheritance of an IRA, the beneficiary has two basic options: 1) take a lump sum cash payment (after a large percentage is subtracted for income taxes), or 2) take required minimum distributions (RMD) each year, according to the life expectancy of the beneficiary. The latter option is known as a “stretch IRA” and is generally a better choice because it allows for continued income tax deferral. The goal is maximizing the parent’s efforts to accumulate income for retirement rather than splurge money for the child.

An IRA Beneficiary Trust requires the use of the stretch IRA option. More plainly, the result compels long term income tax deferral, rather than assuming the beneficiary will choose the fiscally responsible option.

There are other benefits:

  • In the event of a beneficiary’s death, divorce, or incapacity the IRA Owner can devise a contingency plan for the IRA funds.

  • At the surviving spouse’s death the IRA Owner can direct the account balance to their children from a prior marriage, rather than spouse’s children or new spouse.

  • Continuing the income tax deferral over a longer period will result in the Beneficiary receiving a much larger inheritance.

  • The inheritance fund is protected from divorce actions, ex-spouses and frivolous lawsuits.

  • Inheritance by special needs beneficiary will not jeopardize eligibility for government benefits.

3. Does the IRA Owner Lose Control of the Account During Their Lifetime?

No. An IRA Beneficiary Trust will not alter anything regarding the Owners retirement planning until after the Owner’s death. There are no restrictions on investments, distributions, or the choice of beneficiaries.

4. What Type of IRA Beneficiary Trusts Provide the Most Asset Protection?

When drafting an IRA Beneficiary Trust there are two options, a conduit trust or an accumulation trust. Both trusts feature asset protection but the accumulation trust is preferred.

A conduit trust requires a trustee to forward the annual required minimum distributions from the IRA account to the beneficiary each year. This flow-through arrangement, or conduit, pays a stream of income to the beneficiary whether needed or not.

In an accumulation trust the trustee is permitted to retain, or accumulate, the required minimum distributions are placed inside a separate account owned by the trust instead of giving them outright to the beneficiary. This accumulated money is then secure from creditors.

A key distinction is the trustee of a conduit trust does not have any discretion in distributing or retaining the annual RMD. The trustee must distribute at least the RMD each year.

The trustee of an accumulation trust may use its discretion and choose whether to distribute RMD to the beneficiary or retain the RMD within the separate account for future distribution of for the purposes of asset protection.

5. Can I Incorporate These Provisions into a Revocable Living Trust?

In general a revocable living trust is focused on dealing with assets otherwise eligible for probate, like real estate and bank accounts, for the purposes of avoiding probate. The IRS has established complex rules regarding retirement accounts payable to trusts. In one specific example if a living trust directs IRA assets to an accumulation trust the RMD will be calculated based on the life expectancy of the oldest beneficiary, including potential beneficiaries. This means that naming a parent as contingent beneficiary of your assets is enough to trigger use of their life expectancy instead of a younger, primary beneficiary’s life expectancy. Living trusts are rarely drafted with the necessary precision to avoid problems like this.