Key Points

• Trusts continue to be an excellent tool for individuals to account for specific needs and restrictions on their IRA and retirement account balances after their passing.

• Trusts need to have “conduit or accumulation” language to retain ownership and effectively become beneficiary of an IRA or retirement plan.

• The decision about whether to pursue conduit or accumulation language hinges on a few factors including long-term tax impact and the degree to which the IRA owner wants to maintain long-term control and restrict beneficiary access.

As we discuss in our Trusts: The Fundamental Estate Document article, trusts are a great tool in achieving multiple objectives when it comes to controlling asset distribution and use both during and after life. Very often in cases where we have a trust (or trusts) established, we look to title and transfer assets into them, so the document’s provisions apply to said assets. One case where it may make sense to exercise a bit of caution is when naming a trust as beneficiary of an IRA or other retirement account.

Why Name a Trust as Your Retirement Plan Beneficiary?

Trusts have traditionally provided a great framework for individuals to plan what happens after they pass away. Trusts allow them to account for specific needs related to their family dynamic and situation. For example, we might recommend a trust in the following situations:

• Limit a Beneficiary’s Control: When a beneficiary might be a spendthrift or without the financial discipline to responsibly handle sizable retirement plan dollars, trusts can be utilized to restrict distributions and stipulate how the money is spent.
  

• Supporting Special Needs & Accounting for Ownership Limitations: Trusts can be useful in situations where a beneficiary is a minor and cannot legally own an account without a custodian. In this case, the funds are to be managed by a trustee in their stead until the beneficiary is a certain age. Trusts can also be used to remove ownership from special needs individuals, so they have access to government benefits.
  

• Second Marriage: In cases where an individual is married multiple times and may have children from a previous marriage, trusts can be a useful tool in restricting an IRA to provide for a second spouse during their lifetime. They then have remaining assets pass on to their children from the previous marriage after the second spouse’s passing.
  

• Creditor Protection: Individuals who have IRAs and employer-provided retirement plan balances are protected from creditors during their lifetime; however, upon their passing, these protections cease, and inherited IRA balances can be subject to creditor claims. Trusts – specifically Irrevocable trusts – can remove ownership of inherited IRA balances from a beneficiary, protecting funds from potential claims.

How Should Trusts be Structured to Become a Beneficiary?

Before a trust can be named beneficiary of an IRA or retirement plan, it must be drafted to include specific “see-through” language. This language stipulates that the ultimate beneficiary(ies) of IRA dollars is an individual(s).

Trusts must also include language which outlines how the funds from an IRA are handled when distributions are made from the account. Typically, there are two paths for trusts to take: Conduit Trust or Accumulation Trust. Conduit Trusts must distribute all IRA and retirement account balances to a trust beneficiary once they’re received from the account. Accumulation Trusts alternatively allow for the accumulation of those distributions in the trust.

Stretch IRA Provision & SECURE Act Impact

In the past, most financial advisors and estate planners had a fundamental choice to make regarding which path to take related to this language and each option’s restrictions and considerations. In most cases, the conduit language made the most sense for tax reasons. Conduit ensured distributed dollars were taxed at the beneficiary’s tax rates as opposed to a trust’s much higher rates. IRAs could be passed down from generation to generation, growing tax free.

With the passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act in 2019, however, the stretch IRA provision was removed for most inherited IRA beneficiaries.

Eligible Designated Beneficiaries for the stretch provision now only include the following:

• IRA owner’s surviving spouse

• Their minor children

• Chronically ill or disabled individuals

• Person aged 10 years or less than the owner

For most beneficiaries who do not meet these criteria, all new provisions stipulate that the full balance of the IRA account must be distributed within 10 years, albeit without annual distribution requirements. This applies to IRAs inherited after December 31, 2019.

Trust Structure & Strategy

In most cases where IRA or retirement account beneficiaries do not meet stretch IRA eligibility requirements, there are major implications in deciding whether to utilize conduit or accumulation see-through language in a trust.

Conduit language tends to make sense in cases where beneficiaries are at lower tax rates and will likely show financial responsibility within a 10-year window. In this case, we can ensure distributions are paid at lower tax rates while maintaining some degree of control for a period of time until the IRA assets are distributed.

Accumulation trusts work in an opposite manner. The IRA distributions are made at the trust level, taxes are paid by the trust, and distribution discretion remains up to the trust terms. 

Understanding and planning for beneficiary needs is a critical need and often helps drive this process. Deciding the best course of action for your trust may be important, but with your Capstone Wealth Advisor, it doesn’t have to be stressful.

Disclosures:

This article is not a substitute for personalized advice from Capstone and nothing contained in this presentation is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. This article is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed by other businesses and activities of Capstone. Descriptions of Capstone’s process and strategies are based on general practice, and we may make exceptions in specific cases. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request.