Advantages of Creating a Trust to Handle Your IRA assets

If you will not need to spend the assets during your life, and want some say over how your assets are used after your death, why not put your Individual Retirement Account (IRA) funds into a trust?

Specifically, that means creating a trust and designating the trust the beneficiary of your IRA. Because you cannot put your IRA in a trust while you are living. When you do name a trust as beneficiary of your IRA, you gain the advantage of specifying how the assets should be handled after your death. That enables you to anticipate and protect against many risks.

The trust option applies to all types of IRA—Roth, SEP, and SIMPLE IRAs– that have proliferated since the IRA was created in 1974 under the Employee Retirement Income Security Act. The intention of the legislation was to motivate working people to save for retirement on their own (future problems of Social Security already were a topic of debate). The need was especially evident for those whose employer did not maintain a pension plan, leaving them to rely solely on Social Security.

IRAs, with their tax advantages, including an initial savings on taxes and then tax-free growth of assets until their withdrawal (“distribution”) on retirement, attracted hundreds of billions in new savings. As one result, Congress was inspired to create additional IRAs with different purposes and different rules.

Your IRA and the trust option

Individuals who have accumulated considerable wealth in IRAs that they will not spend in their lifetime can consider directing that upon their death the IRA assets go to a trust. And stipulate who will benefit from the trust and under what conditions.

It is essential to realize that this process, while not overly complicated for a legal or financial professional, does raise questions to be answered and options to consider. More important, perhaps, is that the wording of the trust instrument must be right or management and the use of the IRA by beneficiaries could be badly compromised.

Only an individual can own an IRA (as the name implies). An IRA cannot be held jointly in two names or owned by an entity (such as a trust or small business). Moreover, the IRA owner almost always must remain the owner; ownership cannot be transferred without being categorized as a taxable distribution. (In other words, liquidation of the IRA, which becomes a taxable event). Moreover, if the IRA owner is under age fifty-nine-and-a-half when the distribution is made, the early withdrawal penalty also applies.

To avoid this entire scenario, the trust you create during your life comes into the picture. It can accept your IRA assets upon your death and becomes an “inherited IRA” held by the trust. What are some major advantages?

Making a trust your IRA beneficiary: Why?

When you name the trust that you created as beneficiary of your IRA, you dictate how the beneficiaries will use their new “savings” (IRA). You can impose special provisions for inheritance that apply to specific beneficiaries. These are questions and options to discuss with our legal/financial advisor. For example, here are two well-known types of situations that you might well wish to address; your right to specify conditions for any particular beneficiary of the trust enables you to do so.

Protecting individuals with weak money-management skills

You may be concerned with good reason that one of your beneficiaries is at risk of recklessly, carelessly, or incompetently spending away the inheritance. You have the option of mandating that the trust’s IRA assets be disbursed on a set schedule, not in a lump-sum payout. Or, you may specify that some of those assets be used for a specific purpose (a common such purpose is education, of course). These desired payment options would direct the trustee of the trust.

Ensuring that children receive a share of the assets

If you are providing for a current spouse to receive some of your assets, but also want to be sure that children of your former marriage receive a share of the assets, too, then that can be accomplished through the trust. As a somewhat related issue, receiving IRA benefits can put at risk the right of a special-needs child to continue to receive Social Security disability benefits. The trust enables you to deal with this situation. You will want to discuss your options for these and other special situations with your legal advisor.

Be sure that you discuss with your advisor how beneficiaries will take possession of the IRA assets and over what time period. That raises essential questions that relate to ‘Inherited IRA’ language. A chief goal in formulating the trust and estate instruments will be to lock in the so-called “stretch option” of distributing the account. That is going to require that terms of the trust specify “pass-through” and “designated beneficiary” and other concepts.

This is important enough to make it worthwhile to ask your legal advisor, also, to review any existing trust if you are not absolutely sure the wording is correct.

Some cautions and options

If you are putting your IRA assets into the name of a trust, designating it the beneficiary of the IRA accounts, does that mean “all” the assets? Not necessarily. And there are some potentially negative aspects of doing so that you should discuss with your advisor.

For example, a trust, as a non-individual inheriting IRA assets, might be subject to accelerated withdrawal requirements and those can kick in within five years of your death. Again, the language guiding the trust must include the “pass-through” terminology in order to lengthen the period of withdrawals to the lifetime of the beneficiaries. Otherwise, your beneficiaries could face some heavy burdens of large relatively rapid distributions.

Nor, in creating a trust, should you give up the considerable advantages of spousal inheritance provisions by naming a trust to hold the assets for your spouse.

That brings us again to the importance of a professional legal-financial advisor who can ensure that trusts make possible the efficiency and relative ease of estate planning of which they are capable. That is the job of a professional working closely with you throughout the process.

You can get in touch with Tanko Law to answer your questions about setting up a trust. We create the trust working with you at each step to clarify options, address special situations, and ensure the most advantageous terms.

Check back here regularly for information, insights, and updates on the spectrum of legal matters and the best practices for managing them.

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