Qualifying a Trust as the Beneficiary of an IRA While Taking Advantage of the “Stretch-Out”

If a person wants to control the distribution of funds held in an IRA after their death, it is possible to do so by naming a trust as the beneficiary of the IRA.  However, in order to minimize tax consequences, the trust named as the beneficiary must be a “look-through” trust which qualifies for payout of the IRA funds over time rather than as a lump sum upon the death of the IRA owner.

While IRAs and qualified retirement plans generally do not require probate, distribution of these assets are controlled by contract law and are distributed pursuant to the beneficiary’s “designations” which were filed with the financial institution prior to the account owner’s death.   A trust can be named as the beneficiary.   However, the structure of the trust will determine whether the proceeds must be paid in a lump sum, and thus subject to potentially significantly higher income tax, or if the Trust qualifies as a “look through” trust in which the payout of the proceeds can be stretched-out over the life expectancy of the oldest beneficiary of the Trust.

You might wonder why the owner of an IRA would want to name a trust as his or her beneficiary, particularly when it is much simpler to merely name the individuals as the beneficiaries.  The primary reason is to control the distributions to the beneficiaries after death. You do not avoid paying taxes by naming a trust.  However, you can prevent your beneficiaries from taking lump sum distributions of your IRA, which would likely result in additional taxes and the remaining balance of which could be squandered by your beneficiaries.  But the purpose of a naming a Trust as the Beneficiary of an IRA is not tax savings.   In fact, it’s quite possible to pay more in taxes even if trust is designed properly. Therefore, you would only use trusts for personal (non-tax) reasons.

In order for this to work, the trust must qualify as a “look-through” trust, (sometimes also referred to as a “see-through” trust).  That means that the trust must be drafted in such a way that the IRS can see through the trust to determine who the beneficiaries are, so that a trust beneficiary is treated as the direct beneficiary of the IRA even though the trust is the designated beneficiary.  In order to qualify the trust must comply with the following requirements:

1) It must be a valid trust under New Jersey estate law.

2) It must be or become irrevocable upon death of the grantor of the trust who is also the IRA account owner.

3) The beneficiaries of the trust must be individuals and must be identifiable in the written trust document.

4) The trustee must provide the required trust documentation to the IRA custodian on or before October 31^st of the year following the death of the IRA owner.

There are a few additional important considerations:

• Some IRA custodians will not allow trusts to be named as a beneficiary. This should be confirmed with the IRA custodian before implementing the trust.
• A properly designed look-through trust is deemed a non-spouse beneficiary and thus must follow post-death required minimum distribution (RMD) rules. When a trust is named as the beneficiary of an IRA required minimum distributions are required to be made from the IRA to the trust, distributions from the trust to the beneficiaries must then be made according to the provisions of the trust.
• The trust can be stretched out based upon the life expectancy of the trust beneficiary with the shortest life expectancy. If there are wide variations in the ages of the beneficiaries, you might want to consider a separate trust for each beneficiary in order to maximize the “stretch-out”.

These trusts are complicated to draft and must be drafted properly in order to qualify as the beneficiary of an IRA and take advantage of the “stretch-out” provisions.   The New Jersey estate planning attorneys at McLaughlin & Nardi, LLC can assist in determining if such a trust would help you effectuate your estate plan.  Call 973-890-0004 or e-mail us to create an estate plan which meets your goals.