Trust versus Individual Beneficiary
Can some one share with me the advantages / consequences of listing a trust as a primary beneficiary versus an individual? I have a client who has IRAs, SEP, Solo(K), and Roth IRAs. He is single, so we listed his daughter as the primary beneficiary on all these accounts. Now the estate attorney is demanding that the primary beneficiary be the client’s trust. Reading Ed’s newsletter and attending his presentations, I was under the impression that you should list individual beneficiaries over a trust when you can. I also need to understand the tax issues involving the RMDs or lump sum distribution. Would a trust be taxes differently or the same as an invidiaul beneficiary? I need some feedback to provide to the client or let him know that changing the beneficiary to his trust is the best course of action. Any advise and direction is appreciated.
Thanks,
Todd
Permalink Submitted by Bruce Steiner on Wed, 2010-08-25 21:46
The reasons for leaving IRA benefits in trust rather than outright are the same as the reasons for leaving other assets in trust rather than outright. Assets passing in trust are better protected against the beneficiary’s potential creditors (including spouses), and will not be included in the beneficiary’s estate.
The tradeoffs are (i) none of the accumulated IRA distributions can ever go to anyone older than the beneficiary whose life expectancy is used to measure the stretchout (in this case, presumably the daughter, or perhaps her husband), (ii) the drafting for (i) above can be tricky, (iii) in order to achieve the protections described above, the trustees will have to accumulate the IRA benefits, which may result in some income tax cost, since trusts reach the 35% Federal bracket at $11,200 of taxable income (in 2010), and (iv) unless the nonretirement assets are small, you won’t want to subject the nonretirement assets to the restrictions in (i) above, which means you’ll have a second trust for the daughter, thus incurring the cost of a second fiduciary income tax return each year.
As to income taxation of trusts, at the risk of oversimplification (income taxation of estates and trusts being complicated), the general rule is that to the extent a trust distributes its income (including, for this purpose, the IRA distributions it receives), the income is taxable to the beneficiaries; and any income not distributed is taxable to the trust.
A Roth conversion may mitigate the income tax cost of leaving the IRA benefits in trust rather than outright.
Unless the amount involved is too small to warrant administering a trust, we generally recommend (very strongly recommend, not demand, since it’s the client’s choice) leaving the IRA (and the other assets) to children in separate trusts for their benefit rather than outright.
For more on this, see my article on this subject in the March 2004 issue of BNA Tax Management’s Estates, Gifts & Trusts Journal: http://www.kkwc.com/docs/AR20041209132954.pdf.