Now that you have considered all the advantages and disadvantages of setting up a trust as your IRA beneficiary (see the May 5th Total Control Money and Tax Tip), you may have decided that because of your personal family situation, it makes sense to add this level of protection to your IRAs.
Now that you have decided to move forward, you have to make sure that your trust qualifies as a “see-through” or “look-through” trust to make sure that it will work. You may be thinking, “What does that mean and why do I care?” Did those questions cross your mind?
If you have a qualified see-through trust as your beneficiary, it allows the oldest of your individual trust beneficiaries to be treated as if he or she were named directly as a beneficiary. The inherited IRA can be stretched out over that person’s life expectancy.
If it does not qualify, no stretch is allowed. According to IRS regulations (Section 1.401(a)(9)-4,A-5), your trust must meet the following requirements to qualify as a see-through trust:
- It must be a valid trust under your state’s laws.
- It must be irrevocable or become irrevocable upon your death.
- The beneficiaries of your trust must all be identifiable.
- Your required trust documentation must be provided to your IRA custodian (or plan administrator of your company plan) by your trustee no later than October 31st of the year following your death.
In addition to meeting all these requirements, if you want to take advantage of the stretch IRA option, you must make sure that all trust beneficiaries are individuals. That means no charities and no estates can be named – you have to pick someone with a pulse!
Now that you know the aspects of making sure your trust qualifies, you have to decide how much control you want after death and how much tax you are willing to pay for that control.
Your inherited IRA will have to distribute the required minimum distribution each year to your trust. If you just want to make sure your beneficiaries get their RMD each year and pay lower income taxes at their own personal rate, you can set up a conduit trust that will automatically distribute your RMD to the beneficiaries each year. Since all of the income is distributed, the beneficiaries will include the income on their personal income tax returns, and you don’t have to worry about hitting the high trust tax rates at a low level of income.
But maybe you want to give the trustee more control. You may want to keep the required money in the trust, but give your trustee more control over what is distributed when and for what reason. You may be subject to higher trust tax rates, but this way you would have the greatest control of your money. This kind of trust is called a discretionary trust, because it allows the income to be accumulated in your trust. It allows a higher degree of protection of your money.
Wow, that is a lot to absorb and sounds a bit complicated, doesn’t it? So think about your situation a little bit more. Are you trying to protect your money from your beneficiary’s divorced spouse or a bankruptcy claim? Or is your beneficiary just totally irresponsible?
Remember, this article is Part II of a three part series. Last week, I spoke about the advantages and disadvantages of having a trust as your IRA beneficiary. This week I spoke with you about the key points you should consider when you are setting up the trust. Part III will address the key aspects you and your trustees/beneficiaries need to know about implementing trust after the death of the original account owner.
With the complexities involved, you want to make sure you understand the basics and find someone who knows what they are doing so that fatal mistakes are not made.
So think a little bit more about your personal situation. If you have any questions, don’t hesitate to call the office and set up an appointment to discuss your situation in more detail.