Why can’t an IRA be in a trust?

Most IRA owners expect to share their retirement assets with their children, grandchildren, and other beneficiaries. However, since IRAs do not restrict how designated beneficiaries can use the inherited assets, some owners may be concerned about how the beneficiaries will manage the lump-sum distributions. Can they transfer the IRA to a trust?

You cannot transfer your IRA to a trust while you are still alive. The IRS requires that IRAs can only be owned by individuals, but not by an entity such as trusts and companies. However, the IRS allows IRA owners to name a trust as a beneficiary in the IRA beneficiary designation form, and provide instructions on how your retirement assets will be shared out after your death.

Can you transfer your IRA to a trust?

You cannot transfer your IRA to an IRA while you are alive. This rule applies to the different types of IRAs like traditional IRA, Roth IRA, SEP IRA, etc. Placing these retirement accounts in a trust would mean retitling the IRA in the name of the trust, which is similar to withdrawing 100% of your retirement assets. Such an action can have adverse tax implications.

When an IRA is transferred to a trust, this transfer is considered a taxable distribution by the IRS, and you will owe taxes on the entire balance of the account. You must include the full retirement account value when filing tax returns for the year you make the transfer. The retirement assets will be taxed at your tax bracket rate. If you are below age 59 ½, you may be subject to an additional 10% penalty for early distribution.

However, if the IRA owner has passed on, the IRA assets of the deceased owner can be transferred to a trust without such tax ramifications. The trust will then manage the inherited IRA and distribute assets to beneficiaries based on the wishes of the deceased owner.

How do trusts work?

A trust is a legal entity that is created to hold assets for distribution to beneficiaries when the estate owner dies. Most IRA owners are concerned that, by distributing retirement assets directly to beneficiaries, the inheritance may not last a lifetime. Usually, once the IRA owner dies, the beneficiaries inherit the retirement assets, and they have full control of the money, and they can withdraw 100% of the money and spend it as they wish.

IRA owners who want their retirement assets to last longer for their children and grandchildren can use trusts to manage the inheritance distributions. When the IRA money passes to beneficiaries through a trust, the IRA owner can put restrictions on when and how much beneficiaries can withdraw, and how the money is spent. This ensures the family assets last a lifetime to benefit the beneficiary’s children.

Where children inherit their parent’s IRA, the trust can ensure that the retirement assets are distributed over a 10-year period, instead of a one-time lump-sum distribution. The trust can distribute the retirement assets based on the 10-year rule so that assets that are not needed immediately can be preserved for future use.

Can a trust be an IRA beneficiary?

An IRA owner can create a trust when he/she is alive, and name the trust as a beneficiary of the IRA. Once the IRA owner dies, the trust must initiate distributions to named beneficiaries. In this case, the trust controls the distributions, and the rules of the trust determine when distributions are made and how much is paid out.

An IRA owner may choose to add a trust as an IRA beneficiary when children are minors. Such an arrangement ensures the trust protects the retirement assets until the children attain the age of majority, or for their lifetime. A trust can also be used to manage retirement assets for beneficiaries who are financially unstable, have marital problems, or are struggling with debt. An IRA trust protects these beneficiaries from creditors, lawsuits and divorce processes.

Generally, the trustee is required to pay the minimum distributions to beneficiaries, based on their life expectancy. However, the trustee can decide to pay a higher amount than the required distributions. The trustee may also be required to make minimum distributions to beneficiaries until they reach a specific age when they (beneficiaries) will have full control of the distributions.

An IRA trustee is often set up as an irrevocable trust, meaning the IRA owner is allowed to change the terms of the trust while alive. The IRA owner can change the beneficiaries, change the distribution patterns, or even change the amount that each beneficiary will get.

Pros of a Trust IRA Beneficiary

One of the advantages of naming a trust as a beneficiary to an IRA is that IRA owners can determine how beneficiaries use their savings. The owner can decide when and how much withdrawals beneficiaries can take, and how these funds are spent.

The trust also controls the IRA assets distributed to special needs beneficiaries who may be incapable of managing decisions on their own. This prevents these beneficiaries from making bad investments with the money.

With a trust as a beneficiary of an IRA, there is some form of creditor protection for the IRA assets. This protects beneficiaries struggling with debts or facing lawsuits from losing their inheritance.

Cons of a Trust Beneficiary

Designating a trust as a beneficiary to an IRA is not always a good thing. These beneficiaries are subject to accelerated withdrawal requirements, the IRS requires trusts to distribute retirement assets within 10 years after the account owner's death. This means the spouse of the deceased owner does not have an option to spread distributions over their lifetime.