Will an IRA affect my estate plan?

Even if you set up a trust, you will continue to individually own your IRA and list individual beneficiaries for it. Your trust cannot be the owner of your IRA, and naming your trust as the beneficiary of your IRA accounts can be complex. However, your IRA can be an important part of your estate plan, so it is important to understand what options are available and what you can do to provide the maximum benefit to you and your loved ones and other heirs.

How can I make my trust a beneficiary of an IRA?

If you do want your trust to be the beneficiary of an IRA, it is important that the trust qualify for the “look-through” rule. This rule says that the IRS must be able to determine whether there is a designated beneficiary and who that beneficiary is. The four requirements that the trust must satisfy are as follows:

  1. Validity. The trust must be valid under state law — or it would be but for the fact that there is no corpus (principal);
  2. Irrevocability. The trust must be irrevocable or will, by its terms, become irrevocable upon the death of the account owner;
  3. Identification. The beneficiaries of the trust who are beneficiaries with respect to the trust’s interest in the account owner’s benefit must be “identifiable from the trust instrument”; and
  4. Documentation. The plan administrator must be provided with certain documentation: (i) a copy of the trust and amendments (if any), or (ii) a list of all trust beneficiaries, including other details about contingent and remaindermen beneficiaries, as well as giving the plan administrator a copy of the trust instrument upon demand.

If the trust satisfies these requirements, the trust qualifies, and Required Minimum Distributions (“RMDs”) will be determined based on the life expectancy of the trust beneficiary. If there are multiple beneficiaries, RMDs are determined by the life expectancy of the oldest beneficiary. If the trust doesn’t qualify, then the “no designated beneficiary” rule will apply, and RMDs will not be computed according to any beneficiary’s life expectancy — thus, RMDs will be accelerated over a short time period.

Why would I name my trust a beneficiary?

There are some good reasons to leave IRA money to a trust after your death. Typically, it is to benefit someone who can’t be trusted to manage their money: a minor child, a spendthrift, or the spouse of a second or later marriage.

But rules for inherited IRAs are different for spouses and non-spouse beneficiaries. As a spouse who inherits an IRA, you can either "rollover" the funds to your own IRA or wait to take RMDs until your deceased spouse would have been 70½. If you have other income, you may want to wait to take RMDs so your tax bill is lower.

The IRS has stricter rules for non-spouse beneficiaries of an IRA. These beneficiaries have three options:

  1. Cash in the IRA. This means emptying the entire inherited IRA and paying taxes on that sum at one time. If you really need the money that may be your best bet. However, be prepared for a huge tax bill!
  2. Take only RMDs. The IRS requires non-spouse beneficiaries of IRAs owned by people over age 70½ to start taking RMDs within a year of inheriting the IRA. Those RMDs are based on the beneficiaries’ life expectancy, not the life expectancy of the now-deceased owner of the account. So the younger you are, the lower your RMDs.
  3. Cash in and empty the account over five years. You don’t have to stick to the RMDs or take all the money from the IRA at once. You can wait and take any sum you want, but once you start taking distributions beyond your RMDs you have to finish emptying the account within five years.

Option 2, often called a “stretch IRA,” takes advantage of the fact that younger beneficiaries have smaller RMD requirements. Individuals who know their spouses have enough money to live on can extend the benefits of the IRA by naming children, grandchildren, and even great-grandchildren as beneficiaries. However, not all IRAs can be stretched, so consult your IRA provider and/or financial adviser if you are considering this strategy.

Learn how IRAs impact your estate plan.

This is only a brief summary of the IRAs and estate planning; the complete rules surrounding IRAs are much more complicated. To determine how IRAs may fit into your estate plan, talk with a financial adviser and call the experienced Oklahoma City estate planning attorneys at Postic & Bates today for a free, no-obligation consultation.

[As with all our posts, the contents of this article do not constitute legal advice and are subject to our site-wide disclaimer.]