Avoid Trust Tax
I have a $1,000,000 Roth IRA that I want my family trust (FT) to be the beneficiary of when I depart. I want to leave FT instructions for my son’s use of this money to include he can take no more than 5% per year out, and he needs to keep investing the remaining balance until the 10th year, at which time all the balance must come out.
However, I am concerned that earnings of the Roth in the FT might be subject to trust tax during the 10 years. Am I correct? If so, does anyone know a way to control the withdrawals and avoid the trust tax?
Thanks!
Permalink Submitted by Alan - IRA critic on Fri, 2025-06-06 19:02
No. Inherited Roth distributions will be tax free to the trust, but if they are retained in the trust, subsequent gains will be taxed at the higher trust marginal rates.
For example, if each year 50,000 is distributed from the inherited Roth to the trust and accumulated there, the gains on that 50,000 in the trust will be taxable. But if that 50,000 is passed through your son and your son invests that money, the earnings will be taxed at his lower personal rate, but of course he could spend it all, and then no tax but also no money. You could require that the entire 1mm plus all it’s tax free gains remain in the Roth until the end of year 10, but that will not address his emergency needs. You could give the trustee of the trust discretion over these decisions to allow some flexibility.
Permalink Submitted by Ed Ricketts on Sat, 2025-06-07 11:42
You may have given me some hope!
So, if I “require that the entire 1mm plus all it’s tax free gains remain in the Roth until the end of year 10,” at its present +/- 11.5% annual gains made on continuing investment (compounding), the gains are tax free? But if my son withdraws during the 10 years, trust tax is owed?
Thanks Alan!
Permalink Submitted by Alan - IRA critic on Sat, 2025-06-07 13:30
If the Roth is not touched until year 10, all gains generated in the Roth will be tax free. There will be no balance in the trust that could generate either taxes at the high trust rates, or if the trust passed through distributions to your son right away, any gains on that invested income after distribution from the trust would be taxed at son’s lower personal tax rate. The high trust rates will only apply to gains that actually occur in the trust on funds held in the trust after distribution from the Roth and before son is allowed access to those funds.
Again, if Roth distributions are passed through to the son right after distribution, trust rates are avoided. If these distributions are limited to the current spending needs of son, there will no longer be investment gains, and no taxes are owed. What would be lost are the tax free gains that could have been generated in the Roth if the Roth balance was undisturbed until year 10.
After year 10 the Roth will have been fully distributed to the trust, and further gains will be taxable to the trust for the amount that remains in the trust. Once distributed out of the trust to your son, investment gains will be taxed to him at her personal rate.