Considerations before naming a trust as an IRA beneficiary

Naming the beneficiary to your IRA is an important step toward meeting your legacy goals. Unfortunately, many investors take little notice of this step in their wealth planning. Consequently, they create situations that do not maximize the benefits their IRA savings might offer these beneficiaries.

Some investors have created trusts and feel they are the answer to all their estate planning concerns, including who to name as their IRA beneficiary. However, the trust is often named as the IRA beneficiary when there are no exceptional circumstances to do so. While there are certainly reasons, such as a special needs beneficiary, when it would be appropriate, in most instances a trust is a poor IRA beneficiary. This is because having your trust listed as the IRA beneficiary may have tax and other consequences that could negatively affect your heirs.

Qualified "look-through" trust requirements

The trust must meet the following requirements in order for it to be considered a qualified “look-through” trust:
  • The trust is a valid trust under state law.
  • The trust is irrevocable or will, by its terms, become irrevocable upon the IRA owner’ s death.
  • The beneficiaries of the trust are identifiable from the trust instrument.
  • Certain documentation has been provided to the IRA trustee, custodian, or issuer.
Once these rules are satisfied, the IRA custodian, under direction of the Trustee, can usually make the payments to the trust for distribution to the individual beneficiaries.

Categories of beneficiaries

The Setting Every Community Up for Retirement Enhancement (SECURE) Act has changed the distribution options for certain beneficiaries who inherit an IRA on or after January 1, 2020.

The table below summarizes the trust categories.

Non-Designated Beneficiary Designated Beneficiary
- Non-qualified trust - Non-spouse individual
- Qualified "look-through" trust

Trust distribution options

The table below summarizes the options for a trust named as an IRA beneficiary, and if the owner died before or after their Required Beginning Date (RBD). RBD is generally April 1 following the year you turn age 72.

Beneficiary category Life expectancy Five-year rule Ten-year rule
Designated beneficiary: - qualified trust X
Non-designated beneficiary (owner died before RBD): -Estate-non-qualified trust X
Non-designated beneficiary (owner died after RBD): - Non-qualified trust X

Distribution options

  • Open an Inherited IRA — An Inherited IRA is a way to keep the funds growing tax-advantaged, while taking distributions. The account titling will always refer to you as the deceased IRA owner with the trust listed as the beneficiary. Since a trust isn’t the owner, the trustee may not make contributions or 60-day rollover deposits to this account.
Inherited IRA distribution options are:
  • Ten-year rule — This option is available for Inherited Roth and Inherited Traditional IRAs. The Inherited IRA must be emptied by the 10th year following the year of the IRA owner’s death. No distributions are required before the 10th year. Depending on the size of the account the trustee may want to spread distributions over the 10-year period.
  • Life expectancy — This option is available if the trust is not a qualified “look-through” trust and you die after your RBD. The distributions are based on your single-life expectancy (term-certain) in the year of your death. These RMDs will begin the year following your death. Qualified trusts that inherit an IRA prior to January 1, 2020 will use the age of the oldest trust beneficiary to determine RMDs.
  • Five-year rule — This option is used if the trust is not a qualified “look-through” trust and you die before your RBD. Empty the Inherited IRA by December 31 of the year containing the fifth anniversary of the owner’s death. No distributions are required before the fifth year.
  • Disclaim — In some instances a trust may be able to disclaim (refuse) IRA assets within nine (9) months after your death.
  • Lump-sum — This strategy will exhaust the entire account in one distribution, with retirement assets losing their tax-advantaged status. Once the trustee chooses to take a lump-sum distribution of the IRA assets the trust inherited, it cannot be undone.

Key considerations

There are a few things to consider when naming a trust as an IRA beneficiary.
  • The IRS has indicated that a trust that allows for the payment of debts and/or administration expenses of the estate may not be a qualified “look-through” trust. If those estate debts and expenses are paid off from the time of the death of the IRA owner up to September 30 of the year following death, the trust may be a qualified “look-through” trust.
  • You may want to have the trust document examined to see if it would be a qualified “look-through” trust. Additionally, certain trusts might be treated as an Eligible Designated Beneficiary (EDB) with more favorable distribution options. Please seek legal advice to determine what course of action is best suited to your individual needs when naming IRA beneficiaries.
  • There may be family estate planning issues where it is appropriate that there be limitations for the beneficiaries for reasons such as age, health or mental health issues, or spend-thrift concerns. However, the use of multiple IRAs may be something to consider. A prudent strategy you could implement is to have one Wells Fargo Advisor (WFA) IRA with individual beneficiaries named, and a second WFA IRA naming a trust as a beneficiary for the special needs heir. You should seek tax and/or legal advice during the estate planning process.

Managing for taxes

When a trust becomes an IRA beneficiary, taxation is an issue that needs to be discussed with your tax advisor. Trusts are subject to a separate tax-rate schedule that applies only to trusts and estates, for income that is not paid out to the trust’s beneficiaries. This can happen in certain complex trusts or in any cases where not all of the income received by the trust is paid out to beneficiaries in the current year. These trust income tax brackets on any undistributed income rise rapidly, reaching the highest tax rate of 37% for taxable income over $13,450. By contrast, when an individual is named as the IRA beneficiary, the top income-tax bracket of 37% applies only to taxable income over $647,850 for joint filers or $539,900 for single filers.

Talk to Wells Fargo Advisors

We suggest that IRA investors become educated on the various beneficiary planning methods that are now available to determine whether a trust is necessary to meet their legacy goals. At Wells Fargo Advisors, we welcome the opportunity to work with you and your tax and legal advisors to help create an IRA strategy designed to help you achieve your desired result.

Please Note: This material has been prepared for informational purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Trust services available through banking and trust affiliates in addition to non-affiliated companies of Wells Fargo Advisors. Wells Fargo Advisors and its affiliates do not provide legal or tax advice. Any estate plan should be reviewed by an attorney who specializes in estate planning and is licensed to practice law in your state. The accuracy and completeness of this information is not guaranteed and is subject to change. It is based on current tax information and legislation as of January 2022. Since each investor’s situation is unique, you need to review your specific investment objectives, risk tolerance and liquidity needs with your financial professional(s) before an appropriate investment strategy can be selected. Also, since Wells Fargo Advisors does not provide tax or legal advice, investors need to consult with their own tax and legal advisors before taking any action that may have tax or legal consequences. Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, separate registered broker/dealers and nonbank affiliates of Wells Fargo & Company.