Trust inherited IRA distribution rules

Designating a trust as an IRA beneficiary may be an appealing option for IRA owners who want to control how the money is distributed. Usually, a trust can be named as a beneficiary in special circumstances such as where beneficiaries are minors or disabled individuals. However, trusts are subject to various inherited IRA distribution rules.

If a trust inherits an IRA, it must be structured as a see-through trust to qualify for favorable distribution rules. The SECURE Act requires inherited IRA assets to be fully distributed to the beneficiaries within 10 years following the death of the original IRA owner unless the beneficiary is an eligible designated beneficiary.

Can a trust inherit an IRA?

A trust can be named as a beneficiary of an IRA account, and the terms of the trust determine how the money is distributed to the trust’s beneficiaries. When a trust inherits the retirement assets, the inherited IRA will be maintained as a separate asset-holding account of the trust.

IRA owners can designate trusts as IRA beneficiaries to control how and when specific individual beneficiaries receive distributions from the trust. For example, if the IRA owner has a minor child, the trust can manage distributions for the child until they attain the age of majority. Similarly, if the IRA owner left behind a disabled beneficiary, the trust can manage distributions to ensure they remain eligible for federal and state disability benefits.

Type of trusts that can be named as IRA beneficiaries

When naming a trust as an IRA beneficiary, the IRS requires that the trust must meet certain requirements to qualify as a see-through trust. These requirements include ensuring that the trust is a valid trust under state law, the trust is irrevocable or will become irrevocable upon the death of the IRA holder, trust beneficiaries are identifiable, and that certain documentation have been provided to the IRA custodian, trustee, or issuer.

If the trust meets the IRS requirements of a see-through trust, it is further classified as either conduit or accumulation trust, with each type of trust serving a different purpose. A conduit trust is designed to pay out all distributions to the specified beneficiaries, and the beneficiary is responsible for paying income taxes on the distributions at their income tax bracket.

On the other hand, an accumulation trust allows the distributions to be retained within the trust. It gives the trustee the discretion to determine whether to pay out or keep distributions taken from the inherited IRA. For example, if the inherited IRA is left to an accumulation trust with three named minor beneficiaries, the trustee can reinvest the inherited assets with the trust, and determine when and how to make distributions to the named beneficiaries.

RMD rules for Trusts inheriting IRAs

Before the SECURE Act of 2019, the stretch IRA strategy allowed inherited IRA beneficiaries to spread distributions over their life expectancy. However, the SECURE Act introduced various changes to the RMD rules for inherited IRAs, especially for non-spouse beneficiaries, including trusts.

If a trust inherits an IRA from a deceased IRA owner, the entire balance must be depleted within 10 years following the original IRA owner's death. However, there is an exemption to this requirement if the trust's beneficiaries are eligible designated beneficiaries such as minor children, disabled or chronically ill individuals, and beneficiaries who are no more than 10 years younger than the original IRA holder.

If the trust is managing inherited IRA assets on behalf of a minor child, RMDs can be spread over the life expectancy of the beneficiaries until they no longer qualify as eligible designated beneficiaries. For example, once a minor child attains the age of majority, the 10-year rule will kick in, and they will be required to take all benefits within 10 years.

Why name a trust as an IRA beneficiary?

An IRA owner may decide to leave retirement assets to a trust for several reasons. A trust allows the IRA owner to control how the inherited IRA assets are distributed over time to prevent beneficiaries from quickly depleting the retirement assets.

If the beneficiaries cannot be trusted with a large sum of money, the IRA owner can provide instructions on how and when the assets will be distributed to specified beneficiaries. Where beneficiaries are minors, the trust can make staggered distributions that align with the minors’ milestones or cover essential needs.

A trust can also provide some level of protection from the beneficiaries' creditors. Usually, the original IRA owner enjoys creditor protection, but this benefit is not passed on to the inherited IRA. Passing the IRA through a properly structured trust can provide some protection for the retirement assets from the beneficiaries' creditors.

Downsides to naming a trust as an IRA beneficiary

Using a trust to manage retirement assets for beneficiaries can result in higher income taxes. While conduit trusts allow favorable income tax treatments by distributing funds directly to beneficiaries, accumulation trusts are subject to compressed tax brackets on any undistributed income.

The highest income tax rate for trusts is 37% for taxable incomes above $15,200 in 2024. In contrast, for individual IRA beneficiaries, the highest tax rate is 37% for taxable incomes above $609,351 for single filers and $731,201 for joint filers in 2024.

Additionally, setting up and maintaining a trust as an IRA beneficiary is a tedious process that is subject to various legal requirements. The IRS requires trusts to meet various compliance requirements to qualify as see-through trusts, including providing certain documentation. Failure to comply with these regulations can result in hefty penalties.