By Sarah Brenner, JD
Director of Retirement Education
Everyone has heard the horror stories of how unneeded and unwanted trusts disrupted what should have been a smooth transition of wealth. However, it is important to recognize that estate planning for IRAs is nuanced. Trusts are not all bad and should not be overlooked or dismissed unilaterally. There are times when naming a trust as the beneficiary of an IRA definitely should be considered and may be, in fact, necessary for the best outcome.
One situation where a trust should be considered is when the IRA owner’s minor children are involved. If you want to leave your IRA to an adult, you simply name that person on the IRA beneficiary form. Unfortunately, when it comes to minors, it is not that easy. When a minor inherits retirement dollars, the child is not legally able to make financial decisions. A trust is a good strategy to address this problem.
SECURE Act Impact
The SECURE Act changed the rules for beneficiaries of inherited IRAs, including minors. Now most non-spouse beneficiaries are subject to the 10-year rule. However, there is a special rule for some minors. ONLY minor children of the IRA owner are considered to be eligible designated beneficiaries (EDBs) and can take required minimum distributions (RMDs) based on their single life expectancy until age 21. At that time, the 10-year rule would apply. Annual RMDs would be required to continue during years 1-9 of the 10-year period, and the account would need to be emptied by the end of the tenth year.
Trust for a Minor
The rules for RMDs from inherited IRAs paid to trust beneficiaries can be complex, but it is possible to still get the stretch, like when a trust for a minor child of the IRA owner is named as an IRA beneficiary.
The SECURE Act and its regulations maintain the “see-through trust” rules that existed under prior law. If a trust for a minor child of the IRA owner meets these requirements and the child is the beneficiary of a conduit trust, then RMDs can be stretched over the child’s life until age 21, when the 10-year rule will apply.
Example: Rick died in 2020. The beneficiary of his IRA was a qualified conduit trust established for the benefit of his minor daughter, Ava, age 12 at the time. Until Ava reaches age 21, RMDs from the trust-held inherited IRA paid to the trust can be stretched over Ava’s single life expectancy.
Once Ava reaches age 21, the 10-year rule will apply. By the end of the 10 years, all of the remaining trust-held inherited IRA funds will be paid to the trust. In addition, under the regulations, RMDs must continue (from the inherited IRA to the trust and from the trust to Ava) for years 1-9 of the 10-year term. Since RMDs had already begun based on Ava’s single life, they cannot be stopped during the subsequent 10-year term.
Takeaway
Estate planning with IRAs is complicated and everyone’s situation is different. Naming an unnecessary trust as an IRA beneficiary often brings unneeded complication and no benefit. However, if you are naming your minor children as your IRA beneficiary, a trust may, in fact, be necessary. Be sure to consult with a knowledgeable financial advisor or estate planning attorney to see if naming a trust as IRA beneficiary would be a good strategy for you.
If you have technical questions you would like to have answered, be sure to submit them to mailbag@irahelp.com, to be answered on an upcoming Slott Report Mailbag, published every Thursday.