Understanding IRAs and Trusts

The recent Supreme Court decision Clark v. Rameker has regenerated the debate as to whether it is better to inherit IRA assets in a trust than to receive them outright.  Because of this case, some advisers are encouraging clients to establish new trusts.  However, clients must keep in mind that these trusts generate fees and can make estate planning with IRAs more complicated.  Thus, it is vital to understand what you would be getting into. 

While Clark  is a case that will affect very few people, there are issues to consider.  A trust can protect the IRA assets from other creditors, most commonly a divorcing spouse.  Also consider a trust if you want to control cash flow to heirs that might be regarded as spendthrifts. 

If the intended beneficiaries are minors, you are unable to leave property to them outright, therefore, you will have a choice between naming a custodian for the child who will inherit the IRA, or creating a trust for the benefit of minors, which will in turn be a beneficiary of the IRA.  With a trust you can limit their access to the money, which would otherwise come under their control when they reach the age of majority.  Depending upon the size of the IRA and how much money you want them to have at a young age, this is an option to contemplate. 

A trust with only one beneficiary could use that person’s life expectancy in calculating withdrawals.  In a trust with multiple beneficiaries, the trust would take withdrawals based on the life expectancy of the oldest beneficiary.  When naming multiple beneficiaries however, there is a risk of the stretch-out being shorter than desired, which could happen if there is one beneficiary who is significantly older than the others. 

If you decide to use an existing trust or create a standalone trust for the purpose, ensure you name it on the beneficiary-designation form.  Otherwise, it will not be considered the beneficiary of your IRA.  This last crucial step is a usual mistake. 

See Deborah L. Jacobs, IRAs and Trusts: What You Need to Know, Forbes, Sept. 4, 2014.