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A Hard Look at IRAs as Beneficiaries

An IRA is designed to provide for the retirement needs of the original owner. But IRAs have also become a useful estate planning strategy and a way to protect assets for future generations. Designating an irrevocable trust as a beneficiary of an IRA can provide that protection. However, if you don’t do it right, it can be a pricey mistake, says the Motley Fool in “Can an IRA Go Into an Irrevocable Trust?”

IRAs and see-through trust status. How the trust will get taxed as an IRA beneficiary is the big issue in the set-up. Usually, trusts aren’t eligible to leverage stretch-IRA provisions. This lets some beneficiaries take small distributions throughout their lifetimes. Trusts would instead have to take out all IRA money within the first five years, which would accelerate taxation and potentially create a larger tax bill.

To receive preferential tax treatment for an IRA beneficiary trust, if the trust qualifies for see-through status, the rules governing inherited IRA distributions will disregard the trust as a separate entity. Instead, it will use the life expectancy of the trust’s beneficiary to calculate minimum required distributions. It’s a big incentive to structure the trust the right way to qualify for see-through treatment.

Requirements for a see-through IRA beneficiary trust. To be treated as a see-through trust, a trust must be irrevocable as of the date of death of the owner of the IRA. And the trust has to be validly formed under appropriate state law. But the toughest part is identifying the trust’s beneficiaries. The IRS must be able to determine exactly the beneficiaries of the trust. Then it can assess whether those individuals are able to be designated beneficiaries who can qualify for preferential tax status.

Just one beneficiary who can’t be ascertained as a designated beneficiary can disqualify the entire trust, so there can be no mistakes about beneficiaries when creating this trust. If there are multiple beneficiaries, the oldest one’s life expectancy will be used to determine required minimum distributions.

The financial institution that’s acting as custodian of the inherited IRA must also receive a copy of appropriate documentation of the trust arrangement and the designated beneficiaries. This has to be done by October 31st of the year following the year of the original IRA owner’s death.

Although using a trust as an IRA beneficiary makes estate planning a bit more complicated, it gives you some added protection. Follow the rules to avoid an unintended bad tax result.

Reference: Motley Fool (April 2, 2016) “Can an IRA Go Into an Irrevocable Trust?”

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