As you likely know, an Individual Retirement Account (IRA) is a savings account specifically designed for retirement that allows for special tax advantages. Money put into an IRA is not taxed as income at the time. Instead, it is taxed when the money is withdrawn later. This allows the money to grow at its pre-taxed value while it is in the IRA. At the age of 70.5, the account owner must begin taking required minimum distributions (RMDs) from the account. Generally, there is a limit of $5,000 per year that can be put into an IRA account before the age of 50.

Naming a Beneficiary to an IRA Account

Typically, the financial institution that holds the IRA account will require a beneficiary designation for the funds remaining in the IRA when the account holder dies. Naming a beneficiary ensures that the assets remaining in your IRA account will be passed on to your named heirs. However, there are some challenges that come with naming an individual as the beneficiary of an IRA account. One challenge is that the beneficiary gains control of how to use those assets. You may not want your named beneficiary withdrawing the funds immediately after your death and destroying the safety net you spent a lifetime creating. Another challenge comes if you have a blended family. When you name a beneficiary on your IRA account, he or she takes full ownership of that account. When they die, your account will be distributed by their estate instructions, not yours. For example, if you name your spouse as the beneficiary of your IRA account, he or she may end up designating a new spouse or a child from a previous marriage as their beneficiary, effectively disinheriting your heirs.

Using a Trust to Control How An IRA is Distributed

To retain more control over how your IRA account is distributed after your death, you have two choices that involve “trusts.” One is to create what is called a “trusteed IRA” or an “individual retirement trust.” This means that you agree with the financial institution that holds your IRA that they will act as the trustee and distribute that account to beneficiaries by guidelines that you set. Another option is to create a standalone trust, with a complete set of instructions, that you can name as the beneficiary on the IRA account. There are positives and negatives to each, but they are both ways to exact control over the distribution of your IRA account and to ensure that your wishes are fulfilled after your death.

After your death, there are still going to be required minimum distributions (RMDs) that must be paid out each month from the IRA account. If you choose to use a trust mechanism to control how an IRA is managed, you may restrict distributions to beneficiaries to these minimum amounts, precluding additional withdrawals or cashing out the whole account. You can also choose to provide for additional distributions, beyond RMDs, that can be withdrawn for health, education, or welfare. If you prefer, you could also set an age limit at which time the beneficiary can withdraw the entire account, if he or she wishes. In the meantime, the funds already in the account will continue to grow with all taxes deferred. Restricting distributions in this way allows your retirement account to “stretch” to benefit your heirs over many years.

One of the benefits of creating a trusteed IRA or naming a trust as the beneficiary to an IRA is that you can designate both a beneficiary and contingent beneficiaries. You can specify in the trust guidelines, for example, that you want the RMDs to be made to benefit your spouse throughout his or her lifetime and then to your children. Using these trust mechanisms also provides some protection from the beneficiary’s potential creditors. While a trusteed IRA or standalone trust can’t protect assets that are under the control of your beneficiary, funds held in an IRA and only released through monthly distributions are likely not vulnerable to creditors.

Trusteed IRA

Setting up a trusteed IRA is a simple way to retain control over how an IRA is distributed. When you set up a trusteed IRA, the financial institution that holds your retirement account becomes the trustee. As the trustee for this account, the financial institution will follow your instructions regarding how funds are distributed and who will receive these distributions. Because the financial institution becomes the trustee for your account, you will even be able to provide instructions for how distributions should be handled if you become incapacitated or unable to make financial decisions.

Setting up a trusteed IRA is generally less expensive and simpler than creating a standalone trust. However, there may be some downsides to naming your financial institution as the trustee. Depending on the terms of the agreement with your financial institution, there may be ongoing maintenance fees associated with the bank acting as trustee for your IRA. Another challenge may be if your beneficiary wishes to transfer the IRA to another bank or financial institution. Some trusteed IRAs may contain terms that require the account to remain with the trustee organization.

Naming a Trust as the Beneficiary of an IRA

Another option is to name a standalone trust as the beneficiary to your IRA. This is a more involved and possibly more expensive option, but again, it allows for even more control. Creating a new trust for the distribution of IRA assets allows you to name your own trustee and retains the option for the IRA to be transferred to a different financial institution. While a standalone IRA may be more expensive to establish initially, it may avoid the ongoing cost of paying a financial institution to act as the trustee on your IRA account.

Contact Brian M. Douglas & Associates Today

Please contact our office if you need estate planning services at any stage of life. Call us at 770-933-9009 to schedule a consultation with a Greater Atlanta area estate planning lawyer today.