The Use of Trusts as a Beneficiary for Your Retirement Accounts

When planning for your heirs, it is important to remember unlike many other inherited assets, an individual retirement account (IRA) typically passes directly to your heirs according to the beneficiary forms on file, without having to go through probate.

If your spouse is the beneficiary of your IRA, he or she will have options that are not available to other heirs. A spousal beneficiary is allowed to roll the assets into his or her own IRA, postponing distributions until your spouse turns 70 ½.

For non-spouse heirs, those who inherit a traditional IRA generally must withdraw a minimum amount each year, starting on December 31 of the year after they inherit the account. The heirs can choose to draw out these minimum required distributions over their own life expectancies, potentially allowing the account to continue growing tax deferred for many years. A direct beneficiary of an IRA also has the option to withdraw the funds in a lump sum, incurring a large tax bill.

A common trend among investors is naming a trust as the beneficiary of their IRAs and then naming their non-spouse heir as beneficiary of the trust. While this may achieve certain estate planning goals, there are tradeoffs both you and your heirs should consider before setting up a trust.

Provided the trust meets certain requirements, the IRS will “look through” the trust to the underlying beneficiary as the designated IRA beneficiary, essentially having the heir take distributions based on the life expectancy method. A trust may also protect the inherited assets from your heir’s creditors or a divorcing spouse.

A trust can allow you to control the timing and amount of the distributions, especially if the beneficiary is a minor. If a minor child inherits an IRA the child’s conservator would likely handle the distributions, which would be based on the child’s life expectancy. However, once that child reaches the age of majority, he or she could empty the account and spend the money as he or she wishes. By naming a trust as the beneficiary, and naming your child the beneficiary of the trust, you could dictate from beyond the grave, when your child would have full access to the funds.

However, if a clear beneficiary of the trust inheriting the IRA is not identifiable, the trust may be required to take the payout within five years, causing the assets to be taxed more quickly. Likewise, if the trust is designed so that assets accrue over time, the trust would pay the taxes. Trusts currently reach the highest tax rate at only $12,150, whereas individuals reach the highest rate at incomes in excess of $400,000. Therefore, a trust that accumulates distributions could be taxed significantly more than an individual who receives the distributions.

If a person with a disability were to inherit assets, it may make him ineligible for public benefits, such as Supplemental Security Income, Medicaid Health Insurance or Life Skills Training workshops. Many specialized programs for the disabled are available only to those who are eligible for Medicaid; therefore, preserving benefit eligibility may be important, regardless of a family’s financial resources.

In Georgia, a person receiving Supplemental Security Income and Medicaid is only allowed to have financial resources up to $2,000. The calculation of “resources” for purposes of SSI and Medicaid is complicated. In general, the government may consider cash, bank accounts, savings bonds or stocks; non-personal residence real property, or other assets that could be sold to pay for food or housing. If an individual receiving benefits were to inherit assets through a forgotten beneficiary designation, the individual would likely lose these benefits.

Medicaid will generally pay for hospital bills, physician services and long-term care. By designating a special needs trust as the beneficiary of your assets, you can provide for the supplemental care and services a disabled loved one may need, such as accessible housing, rehabilitation services, home health aides, and assistive technology or therapies not covered by insurance.

To be considered a special needs trust, it must be established by a parent, grandparent, legal guardian or by the court. In many cases, upon the parent’s death, the parent’s will transfers the child’s inheritance to the special needs trust. The trust can also be the named beneficiary on life insurance policies, retirement plans or investment accounts. The beneficiary of the trust must be considered “permanently and totally disabled” under Supplemental Security Income criteria. Under the terms of the trust, the trustee may not be permitted to make payments or distributions that might interfere with government benefit eligibility. Generally, this prohibits the trust from giving distributions directly to the beneficiary.

Even if your beneficiary never needs federal or state public benefits, you may want to consider the special life management needs he or she may have. A well-designed special needs trust can provide supplemental care that can enhance the dignity, productivity and comfort for your loved one. Regardless of your financial situation, preparing and executing a sound special needs trust as part of your estate plan should make more effective use of those resources.

Using a trust is an effective method of accomplishing estate planning goals; however, you should consult both a tax adviser and an estate planning attorney to ensure your IRA passes on to your heirs as you wish. If you are planning for heirs with special needs, it can be complex, so you should seek legal advice from an estate planning attorney with experience in planning for the needs of individuals with disabilities.

If you have questions regarding your estate planning strategy, the experts at Henssler Financial will be glad to help: