When you hold an IRA, those funds can be distributed to the person you name as beneficiary or to an inheritance trust. Some IRA owners choose a trust because it gives them a degree of control over how the assets are distributed after they die.
Q: What is an inheritance trust?
A: Designating a trust as beneficiary can be useful if the intended beneficiary has financial issues and is not a good money manager. That could mean distributing assets according to a certain schedule or simply withholding access until the beneficiary is a certain age. The trust can also provide protection from creditors, if your heir is likely to owe money in a divorce or file bankruptcy.
Q: What are some benefits of having an inheritance trust?
A: A trust can also be used to provide for children from a previous marriage, as long as it meets certain requirements. It could, for example, allow someone to leave enough money to care for their spouse, with remaining funds going to their children after their spouse passes.
Q: What is the difference between a person versus a trust being listed as the beneficiary of an IRA?
A: Designating a trust as the beneficiary of an IRA can be tricky. You’ll need specialized guidance to avoid costly tax mistakes and other unintended consequences. Generally, when someone inherits an IRA, they must withdraw a minimum amount each year.
Q: What are the pros and cons of having a trust compared to a person serving as the beneficiary?
A: Heirs have the option of stretching payments out over their expected lifespan, which means funds can continue to grow with tax-free benefits. When the beneficiary is a trust, the IRS will “look through” the trust and treat the heir(s) as if they were the named beneficiary. That way the trust can take advantage of the same tax-free minimum-distribution strategies.
Q: How does a “look through” effect the beneficiary of an IRA?
A: Several factors can disqualify the trust from this look-through treatment. Trusts in which the oldest beneficiary cannot be clearly identified, or which name a nonperson beneficiary (such as a charity or estate) won’t qualify for look-through treatment. If that happens, payments may be calculated according to the original owner’s life expectancy, as if they were still alive. That could mean a far more rapid payout than desirable.
Q: What happens if your IRA is designated solely to your spouse?
A: With the rollover option, couples can extend the tax benefits of an IRA account for decades, even generations. If you leave your IRA outright to your spouse, he or she has the option to roll those funds into his or her own IRA and defer distributions until age 70 1/2. Then, when your surviving spouse dies, the IRA can be left to younger heirs, using their life expectancy to set distributions.
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