For many Americans, the assets in their Individual Retirement Account represent a significant portion of the wealth they hope to leave to their loved ones. However, trusts and inherited IRAs are complex vehicles that have a lot of details to get right.
Advantages to Naming a Trust as an IRA Beneficiary
While directly inheriting an IRA is perfectly fine for many heirs, it can be inappropriate in some situations. If you name minor children or grandchildren as beneficiaries without additional instructions, a guardian will likely be appointed by a court, which can be a complicated and lengthy process and may reduce the benefit your heirs get from the inherited assets.
For families with children from multiple marriages, a trust can help you make sure every member of your family inherits according to your wishes. If one of your beneficiaries has special needs, inheriting an IRA could jeopardize his or her ability to qualify for Social Security disability benefits or other forms of assistance.
It’s also worth considering whether you think your heirs can handle an inheritance responsibly once they reach adulthood. A trust can explicitly detail how much your heirs are able to receive each year and delay when they gain control over the assets.
Trusts can also protect your family’s wealth from divorce and bankruptcy. A 2014 Supreme Court case found that, unlike your own retirement accounts, an inherited IRA is not protected from creditors in the event of a bankruptcy.1 If you worry that your heirs might face divorce or bankruptcy proceedings, a trust might be worth considering.
Disadvantages to Naming a Trust as an IRA Beneficiary
Trusts are very complex instruments that must be carefully worded to be able to accomplish your objectives. If the trust is not created to meet federal regulations, your heirs could lose most of the benefits of inheriting tax-advantaged IRA assets. For example, if the trust is not accepted as a “see-through” or “look-through” trust, the trustee may be forced to distribute the IRA’s assets over a five-year period instead of stretching the distributions over a longer life expectancy.
Simple mistakes like naming a charity as a trust beneficiary are enough to trigger expensive tax consequences for your heirs.
If you are going to name a trust as a beneficiary, it’s critical to work with an attorney who understands your personal situation and has experience with trusts and inherited IRAs. We also recommend checking with your IRA custodian to make sure that trust provisions are compatible with the document governing your IRA.
In many cases, naming a spouse as primary beneficiary of your IRA and children as contingent beneficiaries is enough to preserve the tax benefits of your IRA for your heirs. Ultimately, choosing beneficiaries for your IRA is a task that is best accomplished with professional advice that coordinates all aspects of your estate strategies. Estate planning is a very complex area and it pays to get the details right.
Keith Schaafsma, MBA, CFP
Keith Todhunter Schaafsma, MBA, Certified Financial Planner, is the senior investment adviser at Ascendant Financial Solutions. She has been creating peace for her clients from financial chaos for over 20 years. She and her husband, Pieter, an artist, love to travel and enjoy the wide open spaces of the Southwest with their two cherished dogs.
Securities offered through Geneos Wealth Management, Inc. Member FINRA/SIPC. Advisory services offered through Ascendant Financial Solutions and Geneos Wealth Management, Inc.
All investing and investment strategies involve risk including the possible loss of principal.
Investment strategies cannot ensure a profit or protect against loss in a declining market.
All investing and investment strategies involve risk including the possible loss of principal.
Investment strategies cannot ensure a profit or protect against loss in a declining market.
