Before naming your trust as the beneficiary of your IRA, make sure you understand why you are doing it and what the potential consequences are. Unfortunately, many people fail to recognize that IRAs are unique assets and while a trust may be ideal for the majority of your estate, naming a trust as the beneficiary of your IRA is not usually the most tax efficient move.
How are IRA distributions taxed when a trust is the IRA beneficiary? The answer depends on how the trust is set up. For example, if the trust is a properly drafted “see-through” trust, IRA RMDs may pass through the trust directly to the individual trust beneficiary. The RMD recipient will be taxed based on his/her individual income tax rate. However, if RMDs are “trapped” in the trust, anything over $12,150 will be taxed at 39.6%.
There is another downside if you have more than one trust beneficiary. Even assuming a trust has been properly drafted, a Multi-Generational IRA (MGIRA) strategy is not available if there are multiple beneficiaries to the trust. They are all stuck using the oldest trust beneficiary’s life expectancy for purposes of calculating RMDs. Why is this important? The incredible opportunity for the youngest trust beneficiaries to enjoy tax-deferred distributions over their (much longer) individual life expectancies is eliminated.
*There are always going to be situations where a trust makes sense and it is the best option for your situation. If you plan to name your trust as the beneficiary of your IRA, be sure that you have all the facts and seek advice from qualified advisors and qualified trust attorneys to ensure your trust will operate according to your distribution plan.