Can a Trust Be Your Designated Beneficiary?
Almost anyone or anything can be the beneficiary of an IRA. However, if the beneficiary is a non-person, the IRA owner is treated as having no beneficiary when it comes to determining the beneficiary’s life expectancy for required minimum distribution (RMD) amounts. This means that if the IRA owner dies before the required beginning date (RBD), the beneficiary is not eligible to use the life-expectancy method to calculate post-death distributions. The beneficiary must therefore distribute the assets within five years. If the IRA owner dies on or after the RBD, the distribution period may not be stretched beyond the remaining life expectancy of the deceased.
This rule for non-person beneficiaries also applies to trust beneficiaries, unless an exception applies, in which case the oldest underlying beneficiary of the trust is treated as the beneficiary of the IRA – for purposes of determining the distributions options. In general, the exception applies if the following requirements are met:
- The trust is valid under state law.
- The trust is irrevocable or will, by its terms, become irrevocable upon the death of the IRA owner.
- The beneficiaries of the trust are identifiable.
- A copy of the trust documents are provided to the IRA custodian by Oct. 31 of the year immediately following the year in which the IRA owner died.
Why Designate a Trust as the Beneficiary
In most cases, an IRA owner designates a trust as the beneficiary of the IRA in order to have control over the disposition of the assets after he or she dies. The following are some reasons why an IRA owner may designate a trust as beneficiary:
- Spendthrift beneficiary protection. An IRA owner may be aware that a beneficiary may squander the inheritance. As such, the IRA owner may want the assets to be disbursed according to a certain schedule instead of in a lump-sum payment. The IRA owner may also want some of the assets to be used for specific purposes, such as financing the beneficiary’s education. The IRA owner can ensure these conditions are met by designating a trust that includes the desired payment options. The trustee of the trust would then be responsible for complying with the trust provisions.
- Providing for children from a previous marriage. An IRA owner may want to ensure that both a current spouse receives income from the assets and children from any previous marriages receive their share of the assets. This can be accomplished by designating a trust that meets certain requirements, such as a qualified terminable interest property (QTIP) trust.
Could Designating a Trust as the Beneficiary Be Problematic?
Designating a trust as the beneficiary of an IRA should be a solution to the IRA owner’s financial planning needs. However, steps must be taken to guarantee that the designation does not create problems for the parties who will inherit the assets. An IRA owner should check with the IRA custodian to ensure that the provisions of the trust are acceptable to the IRA custodian and that they meet regulatory requirements.