Should I Name a Trust as My IRA Beneficiary?

By Joe Cicchinelli and Beverly DeVeny
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This week’s Slott Report Mailbag, proudly sponsored by GoldCo Precious Metals, includes questions on how the pro-rata rule affects pre-tax and tax-free IRA money and how and when you should use trusts as IRA beneficiaries. As always, we recommend you work with a competent, educated financial advisor to keep your retirement nest egg safe and secure. You can find one in your area here.
 

1.

My husband recently opened a non-deductible IRA and contributed $6,500 for 2014, and $6,500 for 2015. Because our income exceeds that which is allowable for a Roth IRA, he used the backdoor approach to a Roth. He is retiring from his career as a teacher in 30 days and is preparing to rollover his pension lump sum ($162,000) and 403(b) ($30,000) into an IRA. This collective sum of $192,000 is pre-tax money. What tax consequences, if any, will this rollover have on the Roth?

Answer:
The amount that he converts will be mostly taxable because of the pro-rata tax rule. That rule states that all of his IRAs this year, including the $192,000 rollover amount, are included when calculating the percentage of pre-tax and tax-free money in his IRAs. Assuming most of the $192,000 rollover funds are pre-tax, then most of the Roth IRA conversion this year will be taxable. He can always recharacterize (undo) the conversion up until October 15 of the year after the conversion if the tax bill is too high or he changes his mind.

2.

My husband’s trust held his IRA. He died at age 76, and was taking his RMD each year. The trust named me, his wife, as beneficiary for my life, and would then pass to the children on my death.

The trust met the requirements stated in your book, as a look-through trust for IRA distribution purposes, and my life expectancy was used to calculate the RMDs.

But my financial institution did not use the Single Life Expectancy table to calculate the RMD after the first year, but subtracted 1 from the divisor each year thereafter, which had a terrible effect on the IRA. I am contesting that action. I think they should be using the Single Life Expectancy table throughout my life.

Thoughts?

P.S I was the same age as my husband.

Answer:
The issue of using your single life factor each year, known as recalculating life expectancy in the IRS regulations, with a trust as beneficiary is complex. Even though you are the beneficiary of the trust, depending on the type of trust it is (conduit versus accumulation) using the reduce-by-one method might be correct. We don’t have enough details to answer your question and recommend that you speak with an advisor with expertise on the trust as IRA beneficiary rules. Remember, you are not the beneficiary of the IRA, the trust is the beneficiary.

3.

How do I leave my IRA to my minor grandson? I am getting all kinds of information on this and it is most important since his mother, my daughter, is deceased and I don’t trust his father, who is married again, with the money.

Should I appoint a custodian, trust, what?  I am getting all kinds of answers on this even from lawyers and it is making me crazy since the child, who is 9, is my only heir, and I want to be sure all is correct so the father cannot gain control. The lawyer said I have a trustee for my estate in my will, but I need to be sure.

In addition, the estate is named as the present beneficiary on the IRA.  How do I do this to protect my grandson and not allow his father to get his hands on any money?

Thank you,

Johanna

Answer:
Appointing a custodian is based on your state’s law and must be discussed with an attorney. With regards to a trust, there are many pros and cons to naming a trust as beneficiary. The main advantage to naming a trust is to control the funds being distributed to a minor after your death. However, the main disadvantages are the cost and complexity. Ideally you would want to name a see-through trust as the beneficiary so the IRA distributions can be paid out over your grandson’s life expectancy. Ultimately, you have to weigh the pros and cons and decide if naming a trust as beneficiary makes sense for you.

Naming your estate as the beneficiary of the IRA is most likely the worst option you could use. It could subject the IRA to probate and claims of creditors. If your will establishes a trust for your grandson, then name the trust as the IRA beneficiary, not your estate.

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This week’s Slott Report Mailbag is sponsored by:
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