Article on Trusts as the Beneficiaries of IRAs
The benefits of IRAs and qualified plans have reached almost mythical proportions. Justifiably so. Deferring income tax liability until distributions of the assets provides the opportunity for tax-free growth of an IRA and, thus, enormous income tax savings.
To maximize the tax savings, the employee generally defers distributions from the IRA as long as possible. After the employee’s death, the beneficiary of the IRA should similarly seek to defer payout of the IRA. Of course, the opportunity for deferral is limited by the Internal Revenue Code’s required minimum distribution (RMD) rules.
During the account’s owner’s (a/k/a the “employee’s”) lifetime, the RMD is calculated to pay out the IRA over the lifetime of the employee and a beneficiary. IRC § 401(a)(9)(A). After the employee’s death, the RMD is calculated to pay out the remaining balance of the IRA over the “designated beneficiary’s” lifetime. IRC § 401(a)(9)(B). Thus, it is advantageous to appoint the youngest possible beneficiary, to the extent consistent with the estate plan. Practical considerations, however, require additional safeguards when appointing a young individual as beneficiary of any substantial asset — including an IRA.
Suppose, for example, that the employee wishes to appoint her grandchild as the IRA beneficiary. Appointing as the IRA beneficiary may be wise in terms of taxation. But, if the beneficiary is a minor at the employee’s death, the beneficiary’s incapacity creates practical problems when the beneficiary becomes owner of the IRA. Moreover, if the beneficiary is a young (or immature or disabled) adult, the employee will be anxious to assure that the IRA is not squandered.
One solution to these problems is to leave the IRA to the beneficiary in trust. This creates two issues, however. First, consider the easy issue: how does one designate a trust as a beneficiary of an IRA without running afoul of the RMD rules? These rules require distribution of the IRA within five years of the employee’s death if the IRA has a non-individual designated beneficiary. IRC § 401(a)(9)(B)(ii).
Second, consider the more subtle issue: In structuring the trust, how does the estate planner assure distribution over the lengthy life expectancy of the young intended beneficiary rather than the shorter life expectancy of some older contingent beneficiary?