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At death, can I leave my IRA or 401k to our family trust as an IRA to avoid liquidating it and paying income taxes?

I think I can leave an Ira to someone without liquidating it. Each year this person would have the option of taking just the required minimum distribution.

But what happens if I try to leave the Ira to the family trust? Does it have to be liquidated and be subject to a tax on the lump sum distribution? If I can pass the Ira to a trust without liquidating it, how is the required minimum distribution calculated?

Dec 05, 2015 by Tony in  |  Flag
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Chris Schiffer Level 14

Tony, You can designate any individual as your IRA beneficiary. Under the IRS Required Minimum Distribution (RMD) rules, beneficiaries can stretch out these RMDs over their own expected life spans. If most cases the beneficiary is significantly younger, giving many more years of income-tax-deferred growth in a traditional IRA or tax-free growth in a Roth IRA.

You can also designate a Trust as your beneficiary of your IRA to establish some control over how distributions will be taken after your death. With a look-through trust you name the trust itself as the IRA beneficiary, and you also select the beneficiary of the trust. Normally, when you name an IRA beneficiary that isn't an individual (i.e., a trust, charity, or your estate), that beneficiary must receive the entire balance of your IRA within five years after your death with the corresponding taxes paid at the time of distrubution. However, special rules apply to trusts. If specific IRS rules are followed, then the trust beneficiary, and not the trust itself, will be deemed the beneficiary of the IRA, allowing RMDs to be calculated using the trust beneficiary's life expectancy and avoiding the five-year payout rule. Because the IRS looks beyond the trust and treats the trust beneficiary and the IRA beneficiary, this is commonly referred to as a "look-through trust."

To qualify as a look-through trust, the following four requirements must be met: 1) The trust beneficiaries must be individuals clearly identifiable (from the trust document) as designated beneficiaries as of September 30 following the year of your death. 2) The trust must be valid under state law. A trust that would be valid under state law, except for the fact that the trust lacks a trust "corpus" or principal, will qualify. 3) The trust must be irrevocable, or (by its terms) become irrevocable upon the death of the IRA owner or plan participant. 4) The trust document, all amendments, and the list of trust beneficiaries (including contingent and remainder beneficiaries) must generally be provided to the IRA custodian or plan administrator by the October 31 following the year of your death.

A trust with just one beneficiary could use that person’s life expectancy in figuring withdrawals. In a trust with multiple beneficiaries, the trust would take withdrawals based on the life expectancy of the oldest beneficiary. IRS regulations provide that trust beneficiaries can't use the "separate account" rule that might otherwise allow each IRA beneficiary to use his or her own life expectancy. If you want each beneficiary to be able to use his or her own life expectancy to calculate RMDs, then you'll generally need to establish separate trusts for each beneficiary to accomplish that goal.

If you designate your family trust as beneficiary of your IRA, it needs to meet the four required criteria above to ensure it meets the look through criteria, otherwise, it may be required to take the payout within five years if the account owner hadn’t reached the required beginning date for taking IRA withdrawals (April 1 of the year after the account owner reaches 70 ½) before he or she died. An attorney should review the trust document to confirm the required language and structure to meet the look through requirements.

Because of the complexities of the taxation rules, selecting beneficiaries for your IRA, 401k and other assets should be done as part of a larger estate planning process that should include your accountant, attorney, financial professional. You should contact me or one of the other advisors on Brightscope of your choosing to discuss in detail what the right decision for you is based on your unique circumstances.

Comment   |  Flag   |  Dec 06, 2015 from BASKING RIDGE, NJ

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