Naming a Trust as beneficiary on IRAs or Annuity Contracts

Submitted by Kenneth Johnston on Wed, 2015-03-25 19:30

Please let me know if there is a way to unwind this nightmare scenario. My client died last year and named her trust as beneficiary on 4 Variable Annuity contracts and a Brokerage IRA. About $500,000 of untaxed money in all. The 3 kids were co-trustees and had all the paperwork signed to have the proceeds of the annuities and IRA pay to the trust and then be distributed to them equally thereafter. 30% taxes were withheld before the money was distributed and extra money reserved if more was needed to do the last tax return of the Trust. Well the trust just got taxed at about a 49% marginal tax rate and the kids still owe about $25,000 more tax.
Trusts must be what Obama meant when he said the “rich ought to pay a little bit more”. My clients aren’t rich so I’m asking if there is a way to get around this unfair tax wrinkle or at least warn someone else who might have arranged their estate plans this way.



Submitted by Alan - IRA critic on Wed, 2015-03-25 22:13

There is no fix I am aware of for the error of having these tax deferred accounts fully distributed to the trust. I take it that there is considerable pre tax money in these contracts that is immediately taxable. If the trust is passing through the income to the beneficiaries, the trust tax rates will not apply, but each beneficiary is still going to face considerable taxable income. I take it that withholding was applied to the trust EIN, and that will have to be passed through to the beneficiaries. At least for the IRA, if the trust is being dissolved anyway, the IRA could have been assigned to the trust beneficiaries and tax deferral could have been extended with only the RMDs being taxable in each year. Annuity options depend on the individual insurer.



Submitted by Kenneth Johnston on Wed, 2015-03-25 22:54

In essence, the trust was only named as beneficiary to make it convenient for the 3 kids to get equal distributions from one source.  I am not aware if there could have been language in the trust that the trust was merely facilitating the payments to the end beneficiary and therefore avoid the higher tax rates that are imposed.  Even if the individuals received the money directly it would have not put them in as high a marginal bracket as what the trust had to pay.  Further comments are appreciated.



Submitted by Bruce Steiner on Thu, 2015-03-26 02:44

  • The compressed tax rates for trusts were enacted as part of the Tax Reform Act of 1986, under President Reagan, not President Obama.
  • It makes no sense to leave an IRA to a trust that immediately terminates and is payable to the children outright.  It would be simpler to leave the IRA to the children, or if you want the children’s shares to remain in trust, to leave the IRA to separate trusts for the children.
  • Even so, the trustees could probably have distributed the inherited IRA to the children, in which case the children could have stretched the IRA over their life expectancies, or at least over the life expectany of the oldest child.
  • The children might want to consult with counsel to discuss whether they might have a claim against the trustees for losing the benefit of the stretch.


Submitted by Bruce Steiner on Thu, 2015-03-26 02:44

duplicate post deleted



Submitted by Kenneth Johnston on Fri, 2015-03-27 17:12

Trust Income over $12,300 is taxed at 39.6% and was passed a couple years ago along with higher tax rates imposed on income earners above $250,000.  At any rate, it’s unfortunate that tax-deferred earnings from annuities and 100% of IRA distributions that pay to a trust as beneficiary has to be treated as if the trust itself created the investments.  I believe the higher tax imposed was intended to tax trusts that earned income from dividends and interest and penalize trust fund recipients who live off of trust income.  But an unintended consequence of this law also ensnared my recently deceased client who named her trust as beneficiary so that her 3 kids would not have confusion or squabble over her assets when they inherited them.



Submitted by Bruce Steiner on Fri, 2015-03-27 22:06

I don’t know what you mean by “her trust.”  A dead person can’t be a beneficiary of a trust.  Do you mean a trust for the benefit of her children?  If so, the trustee can distribute the inherited IRA in kind (without having to take a distribution of the IRA assets) to the children, or to trusts for the children if the trust divides into separate trusts.  The children (or possibly the children’s trusts) can then stretch distributions over their life expectancies, or the life expectancy of the oldest child.  Alternatively, the single trust may be able to stretch the distributions.  In either case, the trust(s) can distribute the amounts it receives if the trustees determine that the income tax benefit of distributing the income outweighs the asset protection and the possible estate tax benefits of accumulating the IRA distributions in the trust.



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