IRA Trust Administration

If you hold significant assets in one or more individual retirement accounts, you might want to consider setting up a special type of revocable living trust that’s specifically designed to act as the beneficiary of your IRAs after you die. This type of trust is referred to by a few different names, including an IRA Trust, an IRA Living Trust, an IRA Inheritor’s Trust, an IRA Stretch Trust, an IRA Inheritance Trust, or a Standalone Retirement Trust.

An IRA Trust is a special type of revocable living trust designed for the sole purpose of holding your IRA accounts for the benefit of your loved ones after your death. You can establish different sub-trusts within the IRA trust agreement for the benefit of your beneficiaries, including your spouse if you’re married. You can design each sub-trust to fit the unique needs of each beneficiary.

For example, you might decide to have the required minimum distributions held inside the IRA trust, which means the funds can only be used for the benefit of the beneficiary as determined at the discretion of the trustee. This is often called an accumulation trust. Or you can have the required minimum distributions paid out to the beneficiary at the time the trust receives each distribution. This type of arrangement is referred to as a conduit trust. If you want to create a lasting legacy for your family, the sub-trusts established within the IRA trust agreement can be set up as lifetime dynasty trusts so they will continue for many years into the future. Finally, since the IRA trust is a revocable trust, you can change the terms of any or all of the sub-trusts at any time prior to your death.
An IRA is an investment account that you own. Each year, you can contribute income that you earn, subject to certain limits. For traditional IRAs, this contribution typically is deductible from your income, and then later withdrawals are subject to income taxation. For Roth IRAs, the contribution generally is not tax deductible, and later withdrawals are tax-free. If you withdraw assets from either type of IRA before age 59 ½, you generally will incur an early-withdrawal penalty of 10%. When you reach age 72, you must start taking required minimum distributions (RMDs) each year from a traditional IRA. The RMDs are based on your age and a life expectancy factor listed in tables published by the IRS. Roth IRAs are not subject to RMDs during your life. Given the way the IRS tables are structured, if you withdraw only the RMDs from your IRA, there will be assets left in the IRA at your death. And, if the IRA has a high rate of investment return, it is possible for your IRA to have greater value at your death than when you started taking RMDs. The IRA with its remaining assets does not pass under the terms of your will or trust, but instead passes to whomever you have named in the IRA beneficiary designation. The most common designations are to individuals – for example, all to a spouse or in equal shares to children. However, a trust also can be named as an IRA beneficiary, and in many instances, a trust is a better option than naming an individual.

When a trust is named as the beneficiary of an IRA, the trust inherits the IRA when the IRA owner dies. The IRA then is maintained as a separate account that is an asset of the trust. Some good reasons to consider naming a trust as an IRA beneficiary instead of an individual include:
• Working around beneficiary ownership limitations. Perhaps the intended beneficiary is a minor who is legally unable to own the IRA. Or, perhaps the IRA owner wants to support an individual with special needs who will lose access to government benefits if he or she owns assets in his or her own name. A solution in both cases could be to name a trust as the IRA beneficiary, which will then become the legal owner in place of the minor or individual with special needs.
• Solving for second marriage or other family structures. An IRA owner may wish for RMDs to benefit his second spouse during the spouse’s lifetime, and then have the remainder of the IRA pass to his own children. If the IRA owner leaves the IRA outright to his spouse, he can be certain that his spouse will benefit, but he can’t guarantee that his children will receive anything. If he instead leaves the IRA to a properly structured trust, his desire to benefit both sets of beneficiaries can be carried out.
• Limiting a beneficiary’s access. We often think of IRA beneficiaries as taking only the required minimum distributions, but an individual who has inherited an IRA has the right to take larger distributions, or even withdraw the entire balance of the IRA. On the other hand, the access of a beneficiary of an inherited IRA owned by a trust will be subject to the terms of the trust.
• Naming successive beneficiaries. When an individual IRA beneficiary inherits an IRA, she can name her own initial successor beneficiaries. If the IRA owner wishes to control the successor beneficiary beyond the initial beneficiary, the owner will need to set forth the succession terms in a trust and name the trust as the IRA beneficiary.
• Providing creditor protection. A person’s own IRA has some level of protection from creditors, but this does not always carry through to the inherited IRA. An inherited IRA held instead in a properly structured trust will not be an asset of the beneficiary and will have some protection from creditors.
• Funding estate plans structured to minimize estate tax. Most estate plans for wealthy individuals include trusts designed to minimize and postpone the payment of federal and state estate tax. For such estate plans to work as intended, the portion of these trusts that shelters an individual’s federal or state estate tax exemption amounts needs to be funded upon the individual’s death. Often, the only asset available to do this funding is an IRA.

Just as there are rules about RMDs during the IRA owner’s life, there also are rules about distributing an inherited IRA after the owner dies. The preferred payout has long been the “stretch IRA,” where the post-death RMDs are stretched out, with annual distributions, over the life expectancy of the new IRA beneficiary. In this case, the IRA could continue to grow tax-deferred, often for many decades after the owner’s death.
The SECURE Act, passed in December of 2019, has significantly reduced the ability to create a stretch IRA. The prior stretch rule has been replaced, for most beneficiaries, with a 10-year rule that requires the IRA to be distributed out completely by the end of the tenth year following the year of the IRA owner’s death. The 10-year rule does not require annual distributions, so long as the full amount is distributed by end of the tenth year. The new 10-year rule does not apply to the following beneficiaries (known as “eligible designated beneficiaries”): the IRA owner’s surviving spouse, the owner’s children while they are minors, certain individuals who are chronically ill or disabled, and any person who is not more than 10 years younger than the IRA owner. The stretch IRA is still available for these beneficiaries.

RMD Rules for Trusts Inheriting IRAs

The post-death RMDs for a trust named as an IRA beneficiary will be calculated under either the stretch payout rule, the 10-year rule, or the 5-year rule, depending on certain attributes of the trust and the trust beneficiaries. It matters whether the trust qualifies as a see-through trust, whether it is a conduit trust or an accumulation trust, and whether the trust beneficiaries are non-individuals, “regular” beneficiaries, or part of the new class of “eligible designated beneficiaries.” The application of the RMD rules to these different types of trusts and beneficiaries is outlined in Exhibit A. The analysis of which RMD rule applies is not always clear, and there are aspects of the SECURE Act that will require clarification through IRS regulations. For these reasons, among others, it is important to involve your estate planning advisor in any decision to name a trust as an IRA beneficiary. You will want to confirm that your reasons for naming a trust as your IRA beneficiary are reflected in the trust terms and will not be negated by the RMD payout rules. It is also important to review beneficiary designations to be sure that any trust beneficiaries are appropriately named. It is important to note that the RMD payout rules are different than the payout rules of the trust.

Even if an IRA must pay out under the 5-year rule to a trust named as the IRA beneficiary, it does not necessarily mean that the IRA assets will distribute out to the trust beneficiaries within five years. Instead, the terms of the trust regarding distribution to trust beneficiaries will apply. For example, if the trust is completely discretionary, then once the IRA assets are distributed out of the IRA to the trust itself, the after-tax proceeds of the IRA will remain invested with other assets of the trust until the trustee exercises its discretion to make a distribution to one or more of the beneficiaries. An inherited IRA refers to an IRA that is passed from the original account holder to a beneficiary after the account holder dies. It is important for people to understand the inherited IRA rules for different beneficiaries and heirs. Whether you will have to pay tax on an inherited IRA will depend on the type of IRA that you are receiving under the inherited IRA rules. You will usually not have to pay inherited IRA taxes if you inherit a Roth IRA. If you inherit a traditional IRA, you will generally have to pay taxes. Spouses and non-spousal beneficiaries have different rules for inherited IRAs. The taxes on an inherited IRA will be assessed at the time that distributions are taken unless it is an inherited Roth IRA.

What are the inherited IRA rules?

Taxes on an inherited IRA are assessed on the distributions that you take in the year that you take them. There are different inherited IRA rules for spouses and non-spouse beneficiaries. Spouses who inherit IRAs have several options under the inherited IRA rules. They may opt to treat the IRAs as their own or to instead to be treated as if they are non-spouse beneficiaries. Under the inherited IRA rules, spouses can choose to roll the assets over into their own IRAs so that they will not have to begin taking required minimum distributions before they reach age 70 1/2, which might help them to avoid being pushed into a higher tax bracket and being forced to pay more tax on an inherited IRA. Non-spouse beneficiaries must begin taking required minimum distributions within one year of the deaths of the original IRA account holders under the IRA distribution rules for beneficiaries. If they do not, they will have to withdraw the entire balances within five years of the original owners’ deaths. Non-spouse beneficiaries can withdraw the money at any time, but they will have to pay inherited IRA taxes on the amounts that they withdraw.

Traditional inherited IRAs are traditional IRAs, SEP IRAs, and SIMPLE IRAs that are left to beneficiaries when the account owners die. SEP IRAs and SIMPLE IRAs become traditional inherited IRAs after the account holders pass away and follow the same rules. Inherited Roth IRAs allow the beneficiaries to take withdrawals without paying taxes. However, they cannot choose to keep the money in the Roth IRA accounts like the original account holders were able to do. Inherited 401(k) accounts are 401(k) plans that are inherited from spouses or from non-spouses. Just like you have to pay tax on an inherited IRA, you also have to pay tax on an inherited 401(k). Under the rules on an inherited 401(k), the taxes on an inherited 401(k) are assessed at the time that you take distributions. The inheritance tax rate when you take distributions from an inherited 401(k) or a traditional IRA is your ordinary income tax rate. The rules on an inherited 401(k) differ depending on whether you are a spouse or a non-spouse. The inherited 401(k) rollover rules allow spouses to roll the funds over into their own accounts. However, the inherited 401(k) rollover rules do not allow non-spouse beneficiaries to roll the funds over into their own accounts. You can roll the funds over into an account that you have designated as an inherited IRA under the inherited 401(k) rules.
Different rules apply for the taxes on an inherited IRA and an inherited 401(k), depending on the type of account. An IRA beneficiary of an inherited traditional IRA must pay taxes on inherited IRA distributions when the money is taken out of the account. Beneficiaries of traditional IRAs may choose to cash out the entire IRA account immediately after the original owner dies. However, using other strategies for IRA withdrawals can help to reduce your tax bill and to defer having to pay taxes on an inherited IRA for years. A stretch IRA allows you to take required minimum distributions over your life based on your life expectancy. The stretch IRA option allows most of the balance of your inherited account to grow tax-deferred. The required minimum distributions that you must take will be included in your taxable income during the years in which you take them. You will not have to pay taxes on an inherited IRA for the money that is inside of the account until you start to take distributions. If you inherit a Roth IRA, different IRA rules for beneficiaries apply as long as the account was funded for at least five years before the owner’s death. In that case, you will not have to pay taxes on an IRA that is a Roth IRA that you have inherited. If the Roth IRA was not funded for five years or longer, you will want to consult with a tax adviser. While you have to pay taxes on an inherited IRA, you do not have to pay taxes on the distributions when you inherit a Roth IRA as a non-spouse. There are no taxes on inherited Roth IRA distributions. However, you must begin taking distributions from the account starting by Dec. 31 of the year that follows the death of the account owner. If you do not, you must withdraw all of the funds by the end of the fifth year after the death. Non-spouse beneficiaries can roll over the money from a Roth IRA that they have inherited into inherited Roth IRA accounts under the inherited IRA rollover rules. However, they cannot roll the funds over into their existing Roth IRA accounts, and they will have to take required minimum distributions on an annual basis. However, while you cannot just leave the money sitting in the account, you will not have to pay taxes on inherited Roth IRA accounts. If you are a spouse who inherits a Roth IRA or a traditional IRA, the inherited IRA rollover rules allow you to roll the funds over into your own account. If you are a spouse who is inheriting an IRA that is a Roth IRA, you will not have to pay taxes on an inherited IRA, and you can allow the funds to continue to grow on a tax-deferred basis.

Importance of choosing a beneficiary for your IRA

Under the IRA beneficiary rules, the proceeds of your IRA are not passed through the provisions of your will. It is vital for you to choose a beneficiary for your IRA. If you do not, the proceeds of your IRA will pass to your estate and will be passed according to the intestacy laws of your state instead of how you might wish the account to be handled. When you open your IRA account, you can designate a beneficiary under the IRA beneficiary rules on the beneficiary designation form. This form allows you to specify how the funds in your account will be handled after you die according to the IRA beneficiary rules. You can name your spouse, child, friend, or a charity or trust as the beneficiary to your IRA. In addition to knowing the IRA distribution rules for beneficiaries, there are some other factors that you should consider. You first need to determine whether you are listed as a beneficiary of another person’s IRA. Remember that under the IRA distribution rules, the beneficiary who is named on the beneficiary designation form will receive the proceeds of the IRA. The beneficiary designations supersede wills. If you are named as a beneficiary and are inheriting an IRA from a parent or have inherited an IRA from a spouse, you should request a trustee-to-trustee transfer of the funds in the inherited account. The distributions from an inherited IRA can be invested in other accounts. You should also make certain that you understand the IRA RMD rules for beneficiaries.