Many individuals make a New Year’s resolution to prepare a Will and to get their estate planning matters in order. However, simply having a Will (and durable power of attorney and living will) may not end the necessary planning. For an individual with a life insurance policy or an IRA that also has young children, the Will may include a trust for the benefit of the children. Unless the beneficial designation of the life insurance policy or IRA is updated to name the trust as the beneficiary, the funds will pass to the children free and clear of the trust provisions outlined in the Will.
Generally speaking, utilizing a trust as part of an estate plan is popular because it gives an individual some control over how the assets are managed and distributed after he or she has passed away. A trust may be designated as the beneficiary of an IRA to ensure that the IRA assets are managed and distributed pursuant to the IRA owner’s wishes and overall estate plan. However, naming a trust as the beneficiary of an IRA should be approached with caution as there are very specific requirements to ensure that the desired treatment is achieved.
In the eyes of the IRS, a trust is considered to be a “non-person”. This is crucial as it impacts the requirement minimum distributions that must be taken from the IRA. When a trust is an IRA beneficiary, the IRA owner is treated as having no beneficiary for the purpose of determining the beneficiary’s life expectance. The beneficiary’s life expectance is utilized to calculate required minimum distribution amounts from the IRA. If an IRA owner passes away before the required beginning date (70.5 years of age) for distributions, the beneficiary is not eligible to use the life expectancy method to calculate distributions. Instead, the assets must be distributed within five years. If the IRA owner passes away after the required beginning date, the distribution period cannot be stretched beyond the IRA owner’s remaining life expectancy. When trusts for younger children are involved, the five year distribution requirement or IRA owner’s remaining life expectancy may be at odds with the terms of the trust.
This rule concerning “non-person” beneficiaries applies to trust beneficiaries, unless an exception is applicable. In general, the exception applies if the following requirements are met:
- The trust is a valid trust under state law or would be but for the fact that there is no corpus of the trust.
- The trust is irrevocable or will, by its terms, become irrevocable upon the death of the IRA owner.
- The beneficiaries of the trust are identifiable.
- A copy of the trust documents are provided to the IRA custodian, generally by Oct 31 of the year immediately following the year in which the IRA owner died.
When an exception applies, the oldest beneficiary of the trust is treated as the beneficiary for the IRA for the purpose of determining distribution options.
In the world of estate planning, one of the more complex technical areas is the intersection of IRAs and trust planning. When reviewing an estate plan as part of a New Year’s resolution or otherwise, it is important to consider the beneficial designations on IRAs and life insurance policies to be sure that the desired treatment is achieved.
