Placing a retirement account in a trust is a bad idea. Generally speaking, there are a lot of good reasons to place an asset in a trust: it can help with long-term care planning, lower estate taxes, protect assets from creditors after death, and provide greater control over asset distribution than a will. But, there may be unfavorable tax ramifications if you consider placing your individual retirement account (IRA) in a trust.
An individual can save for retirement with tax-free growth (Roth IRA) or on a tax-deferred basis (traditional IRA) by opening an account at a financial institution. When the money is invested in your IRA, you don’t have to pay taxes on it. When you take money out of your traditional IRA or “distribute” it, there is only one tax to pay. (Withdrawals from Roth IRAs are tax-free after five years or at age 59 and above.) The IRS states that an IRA can only be owned by an individual.
Property can be held and managed by a trust, which is a legal entity that is frequently used to distribute assets to beneficiaries. Ownership of assets is transferred to the trust by the person who creates it, known as the grantor. Depending on the type of trust being used, assets within it may be taxable to the grantor or to the trust itself. Following the grantor’s passing, a trustee manages the assets for the beneficiaries in accordance with the trust’s guidelines.
It is actually necessary to change the name of your trust as the owner of your individual retirement account (IRA) in order to place it in a trust. Since your trust isn’t regarded as a “individual,” it now violates IRS regulations pertaining to IRA ownership. According to the IRS, you are cashing out of your IRA, and the funds are subject to ordinary income tax. This is an early distribution, and you will be subject to an additional 10 percent penalty tax if you are under 59 1/2 years old. Even worse, the IRS no longer views the money in your IRA as being in an IRA, so you no longer benefit from the tax advantages of an IRA.
The answer is a bit complex. While you cannot directly place a Roth IRA into a trust while you are still alive, you can designate a trust as the beneficiary of your Roth IRA. This means that upon your death, the assets in your Roth IRA will be transferred to the trust and distributed according to the terms you set forth in the trust document.
Here’s a breakdown of the key points to understand:
Why You Can’t Put a Roth IRA in a Trust While You’re Alive:
- IRS Rules: According to the IRS, only individuals can own IRAs. Trusts are not considered individuals, so transferring ownership of your Roth IRA to a trust would violate IRS regulations.
- Tax Consequences: If you were to transfer ownership of your Roth IRA to a trust, it would be treated as a distribution, triggering immediate income taxes on the entire balance. Additionally, if you are under 59 1/2 years old, you would also face a 10% early withdrawal penalty.
How to Use a Trust as the Beneficiary of Your Roth IRA:
- Set Up a Living Trust: Create a revocable living trust during your lifetime. This allows you to maintain control over the assets during your life while ensuring they are distributed according to your wishes after your death.
- Name the Trust as Beneficiary: On your Roth IRA beneficiary designation form, name your living trust as the beneficiary. This ensures that upon your death, the assets in your Roth IRA will be transferred to the trust and distributed according to the terms you outlined in the trust document.
Benefits of Using a Trust as Beneficiary:
- Tax Advantages: Assets held within a properly established trust can continue to grow tax-free, just as they did within your Roth IRA.
- Control Over Distribution: You can specify how and when the assets in your Roth IRA are distributed to your beneficiaries. This allows you to tailor the distribution to their specific needs and circumstances.
- Avoidance of Probate: Assets held within a trust avoid the probate process, saving your beneficiaries time and expense.
- Privacy: The terms of your trust remain private, unlike a will, which becomes public record.
Important Considerations:
- Consult with an Attorney: Establishing a trust and naming it as the beneficiary of your Roth IRA involves legal complexities. Consulting with an experienced estate planning attorney is crucial to ensure everything is set up correctly and aligns with your wishes.
- Review Beneficiary Designations: Regularly review your beneficiary designations to ensure they reflect your current wishes.
- No Beneficiary Designation: If you do not designate a beneficiary for your Roth IRA, the funds will become part of your estate and subject to probate.
While you cannot directly put a Roth IRA into a trust, naming a trust as the beneficiary offers numerous advantages. It allows for tax-efficient distribution of your assets, control over how and when they are distributed, and avoids probate. However, it’s crucial to work with an attorney to ensure the trust is properly established and aligns with your estate planning goals.
Estate Planning Options for IRAs
There are good estate planning options for IRAs:
- Name a trust as the beneficiary of your IRA. There are no adverse tax effects when naming a trust as a beneficiary because it has no bearing on your IRA ownership during your lifetime. This would be a good method to control how your children or other heirs would receive the assets in your IRA after you pass away. But bear in mind that the trust would have to pay income taxes on the mandatory yearly distributions it must make from the IRA.
- Make your spouse the beneficiary your IRA assets. To keep the tax benefit, your spouse can roll over an IRA into their own IRA.
- Retirement accounts allow you to designate your trust as a beneficiary, but you should only do this after speaking with an estate planning lawyer because, if done incorrectly, there may be negative tax consequences.
Your trust shouldn’t hold retirement assets such as an IRA, Roth IRA, 401K, 403b, 457, and the like. Any of these assets would be transferred from your name to the name of your trust if you were to place them in your trust. This could have a disastrous effect on your taxes.
Should a Trust be Named as Beneficiary of an IRA?
FAQ
Can you hold a Roth IRA in a trust?
Can a trustee own an IRA?
Can a trust own an inherited IRA?
Who pays taxes on an IRA in a trust?
Can a trust be a beneficiary of a Roth IRA?
Designate the trust as the beneficiary for your Roth IRA. The Roth administrator can give you the form you need to do this. Once you do this, the Roth will automatically be payable to the trust upon your death. When you pass your Roth IRA through a living trust, your beneficiaries will receive the Roth assets tax-free.
Do IRA owners need a trust?
An IRA owner may want to ensure that both a current spouse receives income from the assets and children from any previous marriages receive their share of the assets. This can be accomplished by designating a trust that meets certain requirements, such as a qualified terminable interest property (QTIP) trust.
How do I put my Roth IRA into a living trust?
There are two steps you’ll need to take to have your Roth pay into a living trust: Set up your living trust. This must be done using a trust document and in accordance with the laws of your state. Designate the trust as the beneficiary for your Roth IRA. The Roth administrator can give you the form you need to do this.
Should IRA assets be paid out to a trust?
Even if RMD rules require that assets be paid out of the IRA to a trust, that does not necessarily mean that the assets must be distributed from the trust to its beneficiaries at the same time. Instead, the terms of the trust instrument governing distributions to trust beneficiaries will apply.