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April 21, 2014

Why you shoud consider naming a trust as the beneficiary of your IRA

Why You Should Name a Retirement Trust as Beneficiary of your IRA

Naming the right beneficiary for tax-deferred retirement accounts is critical. Most people want to continue the tax-deferred growth for as long as possible, pay the least amount in income taxes, and get the maximum stretch-out for their surviving family. Required distributions after the owner dies will be based on the new beneficiary’s age and life expectancy, so the younger the beneficiary (say a child or grandchild), the longer the stretch out.

Naming a beneficiary outright has several disadvantages, particularly  if we are looking at children and/or grandchildren. If the beneficiary is a minor, distributions will need to be paid to a guardian; if no guardian exists, one will have to be appointed by the court. An older beneficiary may be tempted to take larger distributions or even cash out the entire account (just ask your financial adviser how often he or she sees this!), destroying your plans for continued tax-deferred growth. Depending on circumstances, the money could be available to the beneficiary’s creditors and predators (including ex-spouse(s)). There is the risk of court interference if your beneficiary becomes incapacitated, and the extra income could cause a beneficiary with special needs to lose government benefits.

Naming a trust as beneficiary provides more control over, and protection for, these tax-deferred accounts. Such a trust can be integrated into a master revocable “living” trust agreement, or it can be created by a stand-alone trust agreement.

Required minimum distributions (RMDs) will be paid into the trust for the benefit of your beneficiary. The trust can either be mandated to then pay these RMDs directly to the beneficiary (called a conduit trust) or it can accumulate these RMDs (called an accumulation trust) and pay out trust assets according to your instructions (for example, for higher education expenses, down payment on a home, etc.)

Because a trust is the named beneficiary instead of the individual, no guardian is needed for minor children and there is no risk of court interference at the beneficiary’s incapacity. An accumulation trust will allow the trustee to receive the required distributions and use discretion to provide for a special needs beneficiary without jeopardizing government benefits.

Your beneficiary is prevented from cashing out or taking larger distributions, assuring the continuation of tax-deferred growth. If a conduit trust is used, distributions that are paid to the beneficiary (but not the account itself) would be subject to creditor claims. Thus, for maximum creditor protection, an accumulation trust is preferable.

Finally, successor beneficiaries can be named in the trust document, allowing you to keep control over who will receive the proceeds if your initial beneficiary should die before the account is fully paid out.

For more information about stand-alone retirement trusts, please contact our office.