Trusts are used to accomplish a variety of objectives in estate planning and retirement income strategies. There are different kinds of trusts and many ways to use trusts. Most individuals will require the assistance of a tax or legal advisor to establish a trust. In general, a trust is used to transfer legal title of property to a trustee who holds and manages the property for the benefit of a third party, referred to as the trust beneficiary. Certain kinds of trusts can be used to minimize gift and estate taxes while ensuring the assets are distributed as intended. Trusts are also sometimes used as a means of bypassing probate.
Trusts allow the individual establishing the trust (called the grantor) to control to some extent how the trust assets will be used in the future should the grantor become incapacitated or after their death. For example, a trust can be established with clear parameters guiding a trustee in how financial and other assets should be managed and disbursed to care for a spouse, minor children or children with special needs after the grantor dies. This removes the burden of investment decisions and property management from the shoulders of individuals who may not have the ability to handle those matters. The trustee managing the trust has a fiduciary obligation to manage the assets in the beneficiary’s best interests and in accordance with the terms specified in the trust agreement.
A trust is a separate legal entity and in most cases operates as a separate taxpayer with its own tax identification number and files its own tax return. When a trust is named as beneficiary of an IRA, payments from the IRA generally must be made into the trust and Form 1099-R reporting is generated in the name and tax identification number of the trust.
IRA Payment Options for Trust Beneficiaries
For purposes of beneficiary distribution options, a trust is treated as a non-individual and has limited options under the IRS tax rules.
• If death occurred before the IRA owner’s required beginning date for taking required minimum distributions (RMDs) (generally April 1 of the year following the year the IRA owner reached age 70½), the trust must take distributions under the five-year rule.
• If death occurred on or after the required beginning date, the trust must take at least the minimum annual life expectancy payments, which will be based on the IRA owner’s remaining life expectancy.
The IRS has granted special permission to some spouses, who are the sole beneficiary of their spouse’s trust and trustee of the trust, to roll over inherited IRA assets directly into their own IRA rather than having payments made to the trust. This permission applies only to the specific taxpayers who requested a ruling from the IRS. If you have questions about this issue, seek legal counsel for advice on how to handle your specific situation.
Exception to the rule
There is an exception to the general rule that deems a trust as a non-individual beneficiary. If the trust meets the requirements to be a “qualified” trust, the trust has more payment options.
• If death occurred before the IRA owner’s required beginning date, a qualified trust may take distributions under the five-year rule or take life expectancy payments based on the life expectancy of the oldest beneficiary of the trust.
• If death occurred on or after the required beginning date, a qualified trust may take life expectancy payments, based on the longer of the IRA owner’s life expectancy or the life expectancy of the oldest beneficiary of the trust.
Looking through the trust to the age of the oldest beneficiary of the trust may provide a much longer period over which payments may be made from the IRA to the trust, allowing IRA assets to grow tax-deferred.
• For a trust to be qualified:
• The trust must be valid under state law,
• The provisions of the trust must become irrevocable upon death,
• The trust must have identifiable beneficiaries, and
• Either a copy of the trust agreement or a certification of the trust provisions must be provided to the IRA custodian by October 31 of the year following the year of death.
Individuals will typically engage an attorney to draft the trust document and ensure they are following the legal requirements that may vary from state to state. A tax advisor and financial advisor may also be engaged to assist with designing a broader tax and financial strategy, including evaluating investment options that would be appropriate for the trust.
If you have questions about inherited IRAs or beneficiary distribution options, please contact us at 866-928-9394 or Service@StrataTrust.com.