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Using a Trust to Protect Your IRA Account

Over the last couple decades, living trusts have become an increasingly popular alternative to wills. While wills have certain strengths that trusts don’t, such as the ability to name guardians for minor dependents, living trusts have some serious advantages.

In case you aren’t familiar, a living trust a document which can be used to place both real property and financial assets into a sort of legal box, whose contents are watched over by you or another named trustee. When you die, the trusteeship is passed on to whomever you have named in the trust, and they are legally bound to distribute the contents of the trust as you have dictated. The great thing about a trust is that, while a will must pass through probate if your assets have a total value of more than $150,000 (or real property exceeding $60,000), trust assets do not.

One of the other big benefits of having a trust drawn up is that they are incredibly flexible. Homes, cars, cash, stocks—they can all be added to a trust. But given the number of baby boomers approaching retirement, there’s a particular type of financial asset clients often ask about adding to their trust.

Using a Trust to Protect Your IRA Account

IRAs and employer sponsored retirement accounts are not covered by wills, so you don’t have to worry about probate IF you designate beneficiaries.

First of all, in the absence of a trust, wills do not cover funds held in IRAs or 401(k)s. Instead, the contents of your retirement accounts are distributed according to the beneficiary designation forms you fill out when opening the accounts. There are some differences between IRAs and 401(k)s—with an IRA, you can name just about anyone you want as a beneficiary, whereas with employer sponsored plans, your spouse has to provide written permission for you to leave it to any other beneficiary.

This process makes it very easy to leave your investments to desired beneficiaries. If you change your mind, you just file a new designation form. That’s it.

Is it possible to add an IRA to a trust? What are the potential tax complications?

However, some people want to create a layer of legal protection for their retirement accounts, which they accomplish by designating their trust as the beneficiary of the IRA or 401(k). Thus, when they die, the accounts and their contents pass into the trust.

This approach has its benefits and drawbacks. If you’re just intending to leave your IRA to a single heir, using a trust may negatively impact their ability to obtain maximum benefit from their inheritance through the use of “stretch-out.” Typically, people who inherit IRA accounts must withdraw a certain amount each year. But if they like, they can “stretch” these mandatory withdrawals out over their lives. This gives the investments more time to mature and grow, with deferred income taxes on the gains, or in the case of Roth IRAs, tax-free growth.

But for a trust to take advantage of this strategy, it must meet the IRS’s definition of a “see-through” trust. See-through trusts are specifically designed as vehicles for retirement accounts, and have a number of strict specifications, including: they must be valid and legal under state law, witnessed and notarized, irrevocable, and have named, human beneficiaries. The IRS takes the age of the oldest beneficiary and uses this to calculate the amount of the required annual withdrawal.

If your trust doesn’t meet the standard for see-through trusts, then your beneficiaries will have to exhaust the trust in as little as 5 years, depending on whether you had already reached the mandatory age for making withdrawals before your passing.

In addition, if you are planning on leaving your IRA to your spouse, using a trust will deprive them of the opportunity to roll your IRA into their own and defer distributions, and possibly reduce the size of the distributions by using the uniform life expectancy table, rather than the single life expectancy table applied to most inheritors. Lastly, spouses have the option to convert your IRA to a Roth IRA, which can be a big advantage. But all of these options may go out the window if you use a trust.

So, is there a good reason to use a trust for your IRA?

What it comes down to is that there are certain circumstances when it’s a good idea to use a trust. For instance, if you have dependents who are minors, they cannot be listed as beneficiaries until they come of age. In the meantime, a trust in their name is the only way to ensure that they receive the money.

Another good reason is if one or more of your beneficiaries isn’t great with handling money. A trust can be used to dispense funds at a sustainable pace, so they can’t blow through it all at once, and will always have that consistent cash flow to fall back on. Also, if you want to leave your IRA to more than one person, such as your spouse and one or more children, then a trust may be advisable.

The takeaway is using a trust for your IRA isn’t a simple proposition. Your specific situation and goals have to be carefully considered.

In order to have an accurate assessment of the legal implications of your options, you need to work with an estate attorney experienced in the complexities of living trusts and the impact they have on the tax implications of IRAs, 401(k)s, and other retirement accounts. To learn more, contact Toeppen & Grevious by giving us a call at 916-400-4516, or sending us a message using our contact form.