Can you Designate your Family Trust as the Beneficiary of your IRA?

Surprisingly, one of the most challenging assets to deal with in planning for your estate at death is your IRA. “Why is this so difficult?” you ask. Here we present a few challenges and solutions.

First, IRA benefits pass by contract, according to your beneficiary designation. People sign wills and create trusts thinking they take care of everything, but unless you mindfully integrate your IRA with your estate plan, it is not part of your estate plan.

Second, there are complicated tax regulations dealing with IRAs. There are also rules about inheritors’ distributions of the IRA. These rules and regulations are complicated, and most people have not spent enough time to understand them.

Third, the IRS has caused some of the confusion. We’ll tell you why below.

One typical estate planning solution is to name the surviving spouse as the primary beneficiary of your IRA (if you’re married of course), and name the contingent beneficiary as your Trust. Clients and financial advisors routinely question this recommendation. Why? Because the IRS’ own Publication 590 says that “A trust cannot be a ‘designated beneficiary’ (an important term under the Code) even it is a ‘named beneficiary’.” Wow! Can anyone interpret that for me? We have interpreted it and it’s just plain wrong as you will see.

Taxpayers and financial advisors read that sentence and conclude that they can’t designate their Family Trust as an IRA beneficiary, but they are wrong! The incredible thing is the very next sentence in Publication 590 explains how a trust can be named as “your beneficiary”, with some stipulations. The proper type of trust can be named as an IRA beneficiary and at your death, and if you follow the stipulations, the IRS ‘looks through’ to the individual beneficiaries and they are deemed to be the inheritors for tax purposes, not the Family Trust. So the short answer is a properly drafted Family Trust can be named as the beneficiary of your IRA!

    The obvious next question from our clients is ‘Why do I want to name my trust? Isn’t it simpler to just name my spouse and children so it goes directly to them?’ Good question! Here’s just some of the answers I give:

  • Are any of your children minors? Or if not a minor, just how good are they with money? Are you ready to hand them several thousand dollars (if not hundreds of thousands)? Do you expect them to use it properly? If so, then why did we just create a trust to hold their assets until they reach age 25 or 30 or even 40 under the terms of your Will or Trust?
  • What happens if one of the named beneficiaries dies? The truth is we don’t know and neither do you unless you read your IRA custodial agreement…and each one is different! So if you have several IRA accounts or even 401(k) accounts, without reading each one, you can’t know what the result is if a beneficiary dies before you do.
  • Have you looked at your beneficiary designation for that IRA you created years ago? Many clients are surprised to find that when they signed their first beneficiary designation, they had one or two children and now have 3 or 4 children and guess what?…they haven’t updated it. All of their children aren’t named. People tend to ignore this stuff.
  • Do you have a Special Needs child? They will lose governmental benefits until they use up all of their inherited IRA money.
  • Are you concerned about possibilities of drug or alcohol abuse with your child? Only a trust can handle this issue.
  • Do you have a grandchild or other person you want to benefit? How do you handle this?

The simplest answer is to create a good estate plan with a Will and Trust, handling all the issues you care about in your family, then designate the Trust as the beneficiary of your IRA and 401(k)! This integrates the IRA with your estate plan and you do not have to worry about where the IRA benefits will go with each family change.

The Astill Law Office has provided high quality legal services for over 30 years. We specialize in wills, trusts, estate planning, and asset protection. If you have any questions about trusts or estate planning in general, contact The Astill Law Office at 801-438-8698.