Leaving a traditional IRA to a trust may not be the wisest decision.
When you die, you want your family to get your assets in the most efficient way possible.
Perhaps you are considering a trust to avoid having your assets distributed through probate.
Surely this will be the perfect solution.
Not so fast.
According to a recent Madison.com article titled “Consider This Before You Put an IRA in a Trust,” there can be a negative tax impact if a traditional IRA is involved.
You have two choices when it comes to trusts to use with your traditional IRA.
What are they?
One is a conduit trust.
The other is a discretionary trust.
How are they the same?
The required minimum distributions will not pass directly to the beneficiary but will instead pass to trust.
How do they differ?
For a conduit trust, the required minimum distributions will be taxed at the tax rate for the beneficiary rather than the trust when disbursed.
For a discretionary trust, the assets are distributed per the instructions of the trust and are taxed at the tax rate for the trust.
The beneficiary will typically have a more beneficial tax rate than the trust.
Are there reasons beyond bypassing probate to create a trust?
Yes.
If you have children with special needs, minor children, or children with financial immaturity issues, then a trust can be especially beneficial for providing protections and direction.
Although a traditional IRA can pass through a trust, taxes are more complex.
Why?
A traditional IRA is funded with pre-tax dollars.
Growth is then tax-deferred.
This means the money is taxed when withdrawn.
If the owner dies and the IRA is left to someone other than the spouse, this individual is required to take money out.
Now this is fairly simple when it is an individual withdrawing the money.
Withdrawals are calculated based on the life expectancy of the individual.
When a trust is involved, it is more complicated.
The withdrawals are calculated based on the age of the oldest beneficiary.
What if a charity is the primary or remainder beneficiary?
Obviously, life expectancy is no longer a part of the calculation.
Income taxes will be due to the IRS and all of the money must be withdrawn within five years of the death of the original account owner.
Because withdrawals are taxable income, the tax bill could be quite high.
If the IRA is taxed in the trust tax bracket, it could be taxed at up to 40 percent of any amount above $12,400.
The tax rules and reg governing distributions of retirement funds are some of the most complex in the entire Internal Revenue Code.
And, there is a reason for this.
With a tip of the hat to famous bank robber Willie Sutton when asked why he robbed banks ... that is where the money is.
Work with an experienced estate planning attorney to create the most effective and tax-efficient plan for you and your heirs.
So, how do you find an "experienced" estate planning attorney?
First, ask around. Friends, family and other professional advisors are trustworthy sources.
Second, conduct an "organic" search on "Google" for "estate planning" near you (e.g., "Estate Planning Anytown MoKan").
Third, either way, verify! Check out the education, experience, ratings and client reviews of any attorney before you contact him or her.
How?
Two helpful online resources are just a mouse click away to assist with your due diligence: Avvo.com and Lawyers.com.
Check any Avvo ratings, client ratings/testimonials and attorney endorsements on Avvo.com and any "peer ratings" by judges/other attorneys and any client ratings/testimonials on Lawyers.com.
In fact, I use both of these services to thoroughly vett attorneys before referring members of our "client" family for legal help in other areas of law or for matters in jurisdictions outside Kansas or Missouri.
Remember: “An ounce of prevention is worth a pound of cure.” When making your financial, tax and estate plans, do not go it alone. Be sure to engage competent professional counsel.
Reference: Madison.com (August 27, 2017) “Consider This Before You Put an IRA in a Trust”
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