In our last post, we talked about the IRD taxes that your beneficiaries will have to pay after they inherit your IRA. These taxes cannot be eliminated, but they can be reduced with the “stretch out” plan we recommended. Please read our previous blog post for more details, but basically, the plan works like this:
The IRS allows beneficiaries to take out required minimum distributions based on their life expectancy at the time that they inherit the retirement plan. So if you inherit an IRA when you are 50 years old (with a life expectancy of 30 more years), instead of taking out all of the funds at once, you would take out approximately 1/30th the first year, 1/29th the second year, and so on.
This is a very useful plan because it allows the money in the retirement plan to grow tax-deferred. You are basically leveraging your IRA so your beneficiaries end up with a stream of income much greater than the initial value of what they inherited. In order to make sure your beneficiary “stretches out” (instead of cashing out in the first year) an IRA trust would need to be created during the IRA owner’s life. What is an IRA trust and when is it necessary? Read on to find out.
When Do I Need an IRA Trust?
For a “stretch out” plan to work, your beneficiary must be listed individually as a beneficiary on the qualified plan. So, no, you cannot list a revocable living trust as your beneficiary (this would require the plan to be cashed out within 5 years after it was inherited). And unfortunately, sometimes your chosen beneficiary cannot be listed outright as the beneficiary. This might occur if your beneficiary is a minor, has creditor issues, is a spendthrift, or has special needs. In these cases, you must list a special kind of trust to hold the assets for the beneficiary. This is called an IRA trust. But what is an IRA trust exactly and how does it work?
What Is an IRA Trust?
An IRA trust is a legal relationship in which an individual’s IRA is held by one party (the trustee) for the benefit of another (the beneficiary). It allows a trustee of your choosing to manage the qualified retirement plan for the benefit of your beneficiaries while using the “stretch out” plan based on their life expectancies. Listing an IRA trust as your beneficiary is a much better idea than listing your revocable living trust or your estate. It could save you thousands of dollars and ensure your beneficiaries have a great retirement in their own golden years. Considering the uncertainties surrounding Social Security, retirement, and pensions, an IRA trust could be just the solution you need.
Work with an attorney to ensure the IRA trust is written to follow the strict guidelines of the IRS.
Usually, an IRA trust is only recommended if you want to protect your beneficiaries or are not legally able to name them as your beneficiaries. So if you have young children or adult children with special needs, it can be extremely helpful.
- If you’re planning to leave your IRA to your spouse, it is best to name them as the beneficiary outright (without using a trust) so that they can roll your IRA into their own IRA, hopefully deferring distributions and taxes for many years to come.
If you’re still a little confused and wondering, “What is an IRA trust?” please give the attorneys at Parks & Jones a call if you live in the southwest Missouri area. Schedule a free consultation and we’ll help you understand how an IRA trust can work for you and your beneficiaries.
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