Naming a Trust as IRA Beneficiary

Take-Away: Naming a Trust as the IRA beneficiary may not always be the best choice for a retirement account owner.

Background: Often estates and Trusts are named as the beneficiary of a decedent’s IRA. To be clear, it is the estate, or the Trust, that is the actual beneficiary of the IRA, not the beneficiaries of the decedent’s estate or the Trust. That means that the inherited IRA must be re-titled in the name of the fiduciary who is charged with administering the estate or Trust. It is that fiduciary who is then charged with administering that inherited IRA, including transactions, distributions, etc.

While a Trust can be an effective recipient of a decedent’s IRA, that often leads to much more work for the trustee and the trust beneficiaries. For example, the surviving spouse of the deceased IRA owner, if named as the beneficiary of the Trust,  must now deal with the Trust’s terms that govern the use and distribution of Trust asset and abide by the trustee’s administrative and distribution decisions. Obviously, if the Trust is named as the beneficiary of the decedent’s IRA, the decedent’s surviving spouse will be in no position to unilaterally make a spousal rollover.

Surviving Spouses: Fortunately, that IRS has provided several helpful Private Letter Rulings over the years when a Trust is named as the IRA beneficiary and the decedent’s spouse is the sole Trust beneficiary, who has complete control of the Trust’s assets. For example, earlier this year, the IRS in Private Letter Ruling 202404003 (January 26, 2024) allowed a surviving spouse to roll over an inherited IRA asset that was originally paid to a Trust as its primary/designated beneficiary. The Service noted that the surviving spouse was “the sole trustee and primary beneficiary of the Trust…[who] had the authority to distribute all of the Trust’s assets” to herself. Thus, under this PLR, the surviving spouse was treated as having acquired her late husband’s IRA directly from him, and not from the Trust that he had named as its beneficiary. Consequently, the widow was allowed to roll over the distribution of the IRA proceeds tax-free into an IRA in the widow’s own name through a spousal rollover.  While other taxpayers cannot rely on a PLR, the IRS has issued so many PLRs over the years to allow a spousal rollover though a Trust that some IRA custodians will now allow that rollover without requiring a ‘new’ (and very expensive!) PLR.

Decedent’s Estates: Like the treatment of a Trust named as the IRA beneficiary, the IRS has also issued several PLRs where the decedent’s estate was deemed to be the beneficiary of the decedent’s retirement account, where the surviving spouse was authorized to rollover the account balance to his/her own IRA. [PLR 202322013 and PLR 202322014.] The Service has even, albeit in rare situations, allowed non-spouse beneficiaries to establish their own inherited IRAs when the estate was the named as the IRA beneficiary. [PLR 200343030.]

Other Beneficiaries: In addition, there are a few other PLRs that allowed a non-spouse trust beneficiary to have inherited IRAs established for them, without using the Trust. However, without there being total control over the Trust’s assets by the beneficiary,  assigning the inherited IRA assets to the trust beneficiary’s own inherited IRA will probably be rejected by both the IRA custodian and the IRS.

Titling the Account: Some advisers think that with these favorable PLRs in place, bypassing the Trust (or the decedent’s estate) is pretty much standard practice. It is not.

Trust Payout Rules: It should come as no surprise that there are unique (dare I say mind-numbing) payout rules for a Trust-owned inherited IRA. If the Trust satisfies the Tax Code [and Regulations] complex see-through rules, the Trust’s terms are ‘looked through’ to the trust beneficiary and the trustee then uses that individual’s status to determine the applicable payout of the Trust-owned inherited IRA. This is often where folks get confused, and frankly Congress has not helped with the SECURE Act and its 10-year payout rule, the creation of eligible designated beneficiaries who continue to have annual RMD rules, not to mention the rare ghost life expectancy rule. The following Example provides several distribution scenarios that might apply when a Trust is named as the beneficiary of the decedent’s IRA.

Example: Bill, age 65 and a widower,  died owning a traditional IRA. Bill named his Trust as the designated beneficiary of Bill’s traditional IRA. On Bill’s death the IRA assets are transferred to a Trust-owned (and titled) inherited IRA. Hopefully,  Bill’s Trust satisfies the Tax Code’s see-through rules, the Trust will be ‘looked through’ to its beneficiary. Bill’s daughter Molly is the sole beneficiary of the Trust. Molly’s status can then be leveraged by the trustee to determine which payout rule applies.

• If Molly is neither disabled or chronically ill, i.e., she is healthy and not a minor, the trustee can use the SECURE Act’s 10-year payout rule to take distributions from the inherited IRA, either during each year or wait until December 31 of year following the 10^th anniversary date of Bill’s death and empty the traditional IRA in a lump sum distribution to the Trust ;
• If Molly is disabled or chronically ill, meaning Molly is an eligible designated beneficiary, then following the see through rules, a more favorable stretch distribution rule will apply which requires annual RMDs taken by the trustee using Molly’s much longer life expectancy to calculate each year’s RMD;
• If Bill’s Trust fails to satisfy the Tax Code’s see-through rules, then Bill’s Trust must follow the 5-year distribution rule. Under this 5-year distribution rule, there are no RMDs required during that 5-years, but Bill’s IRA must be emptied by the end of the 5^th year after the year of Bill’s death;
• If Bill had been age 73 or older at the time of his death (not 65), i.e., his death was after his required beginning date (RBD), then the trustee could exploit the ghost distribution rule which requires annual RMDs taken from the inherited IRA based upon Bill’s remaining single life expectancy, presuming Bill had survived. Note that the ghost distribution rule uses the year of Bill’s death (not the following year) to identify the initial factor used to calculate the annual ghost distribution [IRS Single Life Expectancy Tables are used for this purpose.]
• Suppose that Bill died owning a Roth IRA (for which there are no RMDs that Bill had to take). If there was no designated beneficiary named for Bill’s Roth IRA, e.g., suppose that Bill’s Trust did not satisfy the see-through rules, then the inherited Roth IRA held by the trustee would be subject to the 5-year distribution rule.

Taxes: We know from prior missives that Trust’s face extraordinarily compressed federal income tax brackets. For 2024, a Trust will be at the 37% marginal federal income tax bracket when the Trust’s accumulated and undistributed income reaches $15,200. [For a quick contrast, a married couple does not reach the 37% federal income tax bracket until their income exceeds $731,200.] But, as noted, this confiscatory income tax only applies to Trust income that is accumulated and not distributed out from the Trust to its beneficiaries. This is why conduit trusts are often named as beneficiaries of IRAs since a conduit trust requires that all trust income (or the taxable income because of IRA distributions to the Trust) must be promptly distributed to the Trust’s beneficiary or beneficiaries. If the Trust is an accumulation trust, its trustee must constantly monitor distributions from the IRA with an eye on the Trust’s marginal federal income tax bracket.

Conclusion: Clearly things get really complicated if a Trust, or the decedent’s estate, is the named beneficiary of the decedent’s IRA. When it comes to naming a Trust as the beneficiary of an IRA, it is extremely important to ‘go slow’ after that death in both how the inherited IRA is titled, the need to confirm if some of the PLRs might apply to enable a spousal rollover, and whether the Trust might qualify as a see-through Trust. It is not impossible, just really complicated.