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Downsides to Naming a Living Trust as IRA Beneficiary

Posted on: July 6th, 2016
living trust disadvantagesIndividuals may name a revocable living trust as the beneficiary of an Individual Retirement Account (IRA) to enjoy additional control over how assets are distributed to trust beneficiaries. Although this method of structuring retirement assets is sometimes more advantageous than simply naming an individual as beneficiary of the account outright, particularly if the beneficiary is a minor or poses a spendthrift threat, if not structured properly it may jeopardize the opportunity for tax-deferred growth of the funds.

One of the benefits of revocable living trusts is that they can be amended at any time. An individual who owns multiple IRAs and names a living trust as beneficiary may choose to amend their trust to name a different beneficiary to receive their estate, including the IRAs. Instead of revising the beneficiary designation forms of each IRA they would simply modify the trust document to provide for distribution of trust assets to their desired beneficiaries. However, this approach might not be advisable in every case for several reasons.
  • RMD. Stretching out Required Minimum Distributions (RMDs) is possible with a revocable living trust, but only if the proper conduit-trust language is included in the trust document. Failure to include such language or improper drafting that does not take income tax rules into account could compromise the desired income tax treatment. Furthermore, care should be taken in designating the beneficiary, as simply naming the trust might not be advisable in some circumstances. 
  • Spouse. Surviving spouses are eligible for IRA spousal rollover benefits that non-spouses do not qualify for. The spousal rollover is not available if a living trust is named beneficiary of retirement accounts. A surviving spouse may face a reduced financial burden and optimal income tax treatment if the retirement accounts are left outright to them rather than to a living trust of which they are the primary beneficiary. The settlor might choose to name a spouse as a primary beneficiary and the trust as a contingent beneficiary.
  • Trust law protections. Living trusts do not provide asset protection during the settlor’s lifetime. Retirement assets paid to a living trust might enjoy some creditor protection depending on the terms of the trust. Inherited IRAs (accounts left outright to individuals and not living trusts) enjoy some creditor protections under North Carolina law. Since 2013, inherited retirement accounts and annuities in North Carolina are protected from creditor claims before and after the account owners’ death.
In most situations, a more advantageous tool is a Standalone Retirement Trust. A standalone retirement trust allows for stretching of RMDs and can include specific language for minor age beneficiaries. Standalone trusts could also delay or limit distributions to help provide for a beneficiary later in their life with minimal tax implications, or include conservatorship instructions to oversee distributions for minors. Standalone retirement trusts may also provide greater protection of retirement assets from lawsuits, divorce claims, and creditors of the beneficiaries.

Establishing a living trust is beneficial for other assets. Real property, personal collectibles (coins, art, wine collections, etc.), bank accounts and investments, and business interests held in a living trust might pose far fewer trust administration risks. 
 
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