Individual retirement accounts (IRAs) do not pass to your family through a will if you have made a beneficiary designation on the account. Your IRA passes directly to the people you named as beneficiary. By the way, this is true for all beneficiary designations – they take precedence over what’s in your Will.
The named beneficiary can do whatever he or she wants with the account’s funds once you’re gone. The beneficiary could cash out some or all of the IRA and spend it, invest the funds in other securities, or leave the money in the IRA for as long as possible.
We pointed out below some reasons why you might not want your heirs to receive your retirement savings all at once. One way to prevent this is to make your IRA beneficiary designation an IRA Trust.
An IRA Trust is a special type of revocable trust specifically designed to act as the beneficiary of your IRA upon your death. IRA Trusts offer a number of valuable benefits to both you and your beneficiaries. If you have significant assets invested through one or more IRA accounts, you might want to consider the following advantages of adding an IRA Trust to your estate plan.
1. Protected Status
IRAs are typically protected from creditors while you’re alive. When you die, the funds pass to your beneficiaries. The IRA can lose its protected status when your beneficiary takes the distributions. However, if you leave your retirement assets to the beneficiary in an IRA Trust, your IRA funds will be shielded from creditors as long as the funds remain in the trust.
IRA Trusts are also useful if you’re in a second (or more) marriage. You can leave your IRA assets in trust first to be used for the benefit of your surviving spouse while he or she is living. After your spouse’s death, the funds can pass to your children. This would ensure that your surviving spouse cannot divert retirement assets to a new spouse, to his or her children from a prior marriage, or lose them to a creditor.
2. Protection from the beneficiary’s own bad decisions
In addition to outside creditors, an IRA Trust can also provide protection from your beneficiary’s own bad decisions. The Trust can protect the beneficiary from their poor money-management skills and spending habits. It can protect them from losing the asset to a failed marriage. If the IRA passes to your beneficiary directly, there is no control over the funds. He can quickly blow through the wealth you’ve worked your whole life to build.
When you create an IRA Trust, you can add restrictions to the trust’s terms to control when and how the money is distributed. For example, you might stipulate that the beneficiary can only access the funds at a certain age or upon the completion of college. Or you might stipulate that the assets can only be used for healthcare needs or a home purchase. With our support, you can get as creative as you want with the trust’s terms.
3. Tax savings
One of the primary benefits of traditional IRAs is that they offer a period of tax-deferred growth, or tax-free growth in the case of a Roth IRA. Yet if the IRA passes directly to your beneficiary at your death and is immediately cashed out, the beneficiary can lose out on potentially massive tax savings.
Not only will the beneficiary have to pay taxes on the total amount of the IRA in the year it was withdrawn, but he or she will also lose the ability to “stretch out” the required minimum distributions (RMDs) over their life expectancy. By the way, this is true, too, if you don’t name a beneficiary and the IRA passes through your estate. The tax savings will be lost.
A properly drafted IRA Trust can ensure the IRA funds are not all withdrawn at once and the RMDs are stretched out over the beneficiary’s lifetime. This provides years—potentially even decades—of additional tax-deferred or tax-free growth.
Minors can’t inherit [outright] an IRA until they reach the age of majority. So without a trust, a legal guardian will have to be appointed to manage the IRA until the child comes of age.
When the beneficiary turns 18 (or 21 – depending on your State), he or she can withdraw all of the IRA funds at once. We’ve seen this play out and it usually isn’t good!
With an IRA Trust, you name a trustee to manage the account for the beneficiary. And remember, you can set the terms for how and when the funds are distributed. You can even ensure the funds are held and invested for the lifetime of your beneficiary.
Find out if an IRA Trust is right for you
The value of IRA Trusts varies greatly depending on your specific family situation, so not everyone will want to put these trusts in place.
Consult with us as your Personal Family Lawyer® to find out if an IRA Trust is right for you.
This article is a service of Susan Hunt, Personal Family Lawyer®. We don’t just draft documents; we ensure you make informed and empowered decisions about life and death, for yourself and the people you love. That’s why we offer a Family Wealth Planning Session, ™ during which you will get more financially organized than you’ve ever been before, and make all the best choices for the people you love. You can begin by calling our office today to schedule a Family Wealth Planning Session and mention this article to find out how to get this $750 session at no charge.