Typically, when the owner of an IRA passes, the assets are given directly to the person, or people, named as beneficiaries of the account. These beneficiaries will receive the money outright. This can cause problems for some beneficiaries for a variety of reasons. Whether it is that they have creditors who will try and stake a claim on the money, they are going through a divorce proceeding and do not want their spouse to be able to receive a part of the inherited money, the original account owner does not trust the beneficiary’s money handling abilities, or the beneficiary is a minor. These are just a few of the many problems that may arise from outright IRA distributions. What can you do to help eliminate these problems? You can set up an IRA Beneficiary Trust
What is an IRA Beneficiary Trust?
When you set up an IRA Beneficiary Trust you name the trust as the beneficiary instead of a person. This means that when you pass, your IRA goes to the trust, not to a person. Why is this of benefit? A properly created trust will be able to take advantage of “stretching” and minimum distribution provisions. How does this work?
Typically, when a person inherits an IRA, they must withdraw a minimum amount from the account each year. This must be done starting December 31st of the following year that the IRA owner passes. Heirs can choose to take this distribution each year instead of taking it as a lump sum. This allows the beneficiary to stretch the money out over their lifetime. This also allows the IRA to grow tax deferred, increasing the total amount the beneficiary receives. It also helps to reduce the taxes the beneficiary pays. An IRA trust allows you to do the same thing, with multiple beneficiaries.
Besides stretching out the IRA benefit amount, an IRA Beneficiary Trust has other benefits. They allow you to control the cash flow to your beneficiaries. This prevents them from getting everything at once. An IRA beneficiary trust will also protect your beneficiary’s money from creditors, it protects the money during a bankruptcy or a divorce. This is the case because the beneficiary does not have direct access to the money. If they were to receive the IRA outright, there would be no protection. The divorce attorney in Boca Raton can help you resolve such issues in your favor.
With an IRA Beneficiary Trust, you are also able to gift money to a minor. Usually, you cannot do this because custodians will not allow you to name a minor as the beneficiary of an IRA. However, with a trust, you can name a minor as a beneficiary, and appoint a guardian who will help them to manage the money and spend it wisely.
With an IRA Beneficiary Trust, you are also able to set up “sub-trusts”. This means that you can set up a secondary trust for each beneficiary named. These sub-trusts will allow you to do such things as holding the Required Minimum Distributions, only to be distributed at the discretion of the trustee. Or you can hold the distributions until the beneficiary reaches a certain age. The planning options are endless.
IRA Beneficiary Trust Rules and Regulations
For you to be able to take advantage of the stretching provisions, your trust must qualify according to rules set out in 26 Code of Federal Regulations Section Sec. 1.401(a)(9)-4. According to this rule, IRA Beneficiary Trusts must follow the following 4 requirements:
- Trust must be valid under state law
- It must be irrevocable or become irrevocable upon the death of the original IRA owner.
- The Trusts underlying beneficiaries must be identifiable as being eligible beneficiaries.
This rule is extremely important to follow. Since the age of the beneficiaries dictates how distributions will take place, the beneficiaries must be easily identifiable. You must either list beneficiaries by name or easily identifiable classes (such as children or grandchildren). You cannot leave the distribution of funds simply up to the discretion of the trustee. Also, you cannot name a charity or an entity as a beneficiary of an IRA Trust. This is the case because these are not living beings and they do not have a lifespan.
- A copy of the trust documentation must be provided to the IRA custodian by October 31st of the year following the IRA owner’s death.
In the instance that your trust does not meet these requirements it will have to pay the money according to established rules. If the original account owner was not 70 ½ before they passed, all of the money must be paid out to the beneficiaries within 5 years. If the original account owner had already reached 70 ½ and begun to take required minimum distributions, the trust will have to pay the money out to the beneficiaries according to the original owner’s life expectancy.
If you desire a more tax effective and efficient way to distribute your IRA funds, an IRA beneficiary trust may be the best choice for you. An IRA Beneficiary Trust, along with other estate planning essentials, can protect your assets from the hassles of probate. Meet with a qualified professional who can help draft these documents for you so you can be ready for the future.
Have questions or want to learn more? Please feel free to contact us here.