Naming a trust as the beneficiary of your IRA

Setting up a trust as your IRA beneficiary can help you accomplish your goals and possibly reduce estate taxes. But it works only if you have sufficient assets and the right objectives and individual circumstances.

Setting up a trust as your IRA beneficiary can help you accomplish your goals and possibly reduce estate taxes. But it works only if you have sufficient assets and the right objectives and individual circumstances.

You need:

Sufficient assets. Many experts say you need at least $1 million in your IRA.

The right objectives—any one or more of these:

• Leaving money to multiple beneficiaries in different generations—such as your spouse, children or grandchildren. This is difficult to do with the IRA custodian’s standard beneficiary designation form.

• Minimizing estate taxes.

• Leaving a substantial sum to charity, and at the same time providing for your surviving spouse.

• Post-death control.

The right lawyer. You should use an experienced trust lawyer. This area of tax regulation is rife with pitfalls. One mistake and you can end up changing the tax status of your IRA.

But the advantages can make a trust worthwhile. A married couple with substantial IRA assets can create a bypass trust to be the IRA beneficiary (if there are no other assets to fund the bypass trust). This trust can save substantial estate taxes. The trust can preserve each spouse’s exemption, up to a total of $4 million now, or $7 million in 2009.

Another benefit is the ability to safely leave money to young relatives: the trust terms can dictate that, when paid, the IRA assets are paid to beneficiaries. If money is left outright to your teenage niece, she can go through those assets fast. The trust can specify that she won’t get the money until she’s older and presumably wiser.

Someone who wants to give a substantial sum to charity but also provide for the surviving spouse can name a charitable remainder trust as the IRA beneficiary. Other advantages include creditor protection, protection against asset distribution in case of divorce, and also providing for professional investment management after death.

Disadvantages of trusts include marginal income tax rates that kick in at lower levels than for individuals, legal and trustee fees, the need to file annual trust tax returns once the IRA owner dies and the trust receives assets, and added complexity in general. Additionally, if your IRA custodian (bank, insurer, or broker) does not permit you to name a trust as the beneficiary, you’d have to switch custodians.

If you have $1 million or even a few million dollars in your IRA, it’s far from automatic that a trust is the right solution. It all depends on what your objectives are, and what assets you have both in and outside of your IRA.

Jeremy T. Welther, CFP, is an IRA expert with Brinton Eaton Wealth Advisors, a planning and investment firm in New Jersey. Brinton Eaton Wealth Advisors (http://www.brintoneaton.com) is a leading fee-only financial-planning, tax-advisory, and investment-management firm in Morristown, N.J.