Wait, I thought everything went into my trust? The answer is important because you want to take the best advantage of your IRA, with its deferred tax structure. You may think that your chosen beneficiary will operate the IRA under the same rules as you do – and unfortunately that is not the case. The critical question is the “measuring life” for the IRA account. IRA’s have what are called “required minimum distributions” and those are based on the value of the account and life expectancy tables set by the IRS. When your beneficiary inherits your IRA the question becomes whose life will be the “measuring life” for the account.
If your spouse is the beneficiary:
Spouses are the only people who have the option of “rolling over” the IRA into their own IRA. The rollover can be as simple as re-titling the account in the surviving spouses name. The spouse then becomes the “measuring life” for the account, and can name their own beneficiaries.
If your children are the beneficiaries
Heirs of an IRA (as named in a beneficiary designation on the account) can stretch an IRA throughout their lifetime, letting the value increase tax deferred for decades. The problem with naming a trust as the beneficiary is that a trust has no life expectancy and therefore the funds will have to be withdrawn, incurring income taxes.
So how do you make sure your beneficiary will be the measuring life for your IRA? You name the individual person as your designated beneficiary through the forms your IRA sends you. Then when the person inherits the IRA, they need to be careful in how they title the account to avoid disqualifying the account. They should re-title the account so it reads like this “John Williams, Deceased (date of death) IRA F/B/O (for benefit of) James Williams, Beneficiary.”
The Conduit Trust
But I thought you just said not to name a trust as a beneficiary? True, not “any” trust should be named as a beneficiary of an IRA. There are circumstances when the funds should be kept in a trust, for example if the beneficiary is disabled and relies (or will rely on) government assistance, or in the case of a second marriage where you want to limit access to the trust principle.
These are circumstances that your normal probate avoidance trusts are not designed for. Additionally, the trust must be specifically designed to meet the IRS guidelines laid out in Treas. Reg. § 1.401(a)(9)-4, A-5. The critical element in these trusts is the trust’s designated beneficiary. If all the elements are correct then the intended beneficiary of the trust will be the “measuring life” for the IRA account, with the benefits of having the trust structure.