Should I Name a Trust Beneficiary of a Roth IRA?

POSTED ON: June 21, 2021

Can a living trust be the beneficiary of a Roth IRA?

Should I Name a Trust Beneficiary of a Roth IRA?

The simple answer is yes, a living trust can be the beneficiary of a Roth IRA. However, without knowing more about an individual’s specific circumstances, it’s hard to know if this is a wise move.

A November 2018 article from NJ Money Help entitled, “Be careful when choosing a beneficiary,” explains that there are several things you need to know when considering a living trust as the beneficiary of a Roth IRA.

It is important to keep in mind that by designating a living trust as your beneficiary, the distributions from the Roth at your death will become mandatory based on the life expectancy of the oldest beneficiary named in the trust.  This rule goes against the a general strategy in naming a trust as a beneficiary: stretch out.

A Roth IRA (or a traditional IRA for that matter), can generally be stretched out over 10 years after you die.  The exceptions to this rule are discussed in this article by Kiplinger Magazine: Who Can Still Do a Stretch IRA after the SECURE Act: Explaining the Exceptions to the Rule.

Even though the SECURE Act substantially limited the income tax benefits of stretch out IRAs, the stretch out under the 10 year rule is still a powerful tax planning device, especially for beneficiaries who are minors.  The younger the beneficiary, the longer the period of time that the investments can grow tax free.

Accordingly, if you establish the trust as a beneficiary of your IRA (either Roth or traditional), and one of the beneficiaries of the trust is a person in your generation, without special language in the trust, the payments must be made over the lifetime of the oldest beneficiary of the trust pursuant to the RMD of that person.  If one beneficiary is age 70 and another beneficiary is a grandchild aged 5 for example, this could be a huge mistake because that grandchild’s distribution would have to be made according the the RMD of the 70 year old.  By contrast, a properly established trust can defer payments to the grandchild until the grandchild is at least age 28 (resulting in 23 year payout during which the investments in the IRA can continue to grow tax free).

Keep in mind that the spousal rollover rules still apply, so that if you have a spouse, you may want to make your spouse the primary beneficiary of the IRA, and the stretch out trust the contingent beneficiary.  In other words, current law permits IRAs to be passed to a spouse as a beneficiary, and the spousal beneficiary can treat the account as if it was their own IRA.

In the case of a Roth IRA, this means the surviving spouse can continue to defer distributions tax-free for their lifetime.

By naming a living trust as beneficiary, this benefit is lost no matter if your spouse is one of the living trust beneficiaries.

Why?

Distributions are required to begin immediately, if the beneficiary is anyone other than a spouse.

Thus, you would forgo the ability to allow the funds to continue to grow tax-free for a longer period of time.

You should talk about this with an experienced estate planning attorney. He or she will be able to look at your entire financial situation before you determine if this is a wise move for you.

If you have a substantially large IRA, you no doubt understand the benefits of tax free compounding.  You can still effectively transfer this tax free compounding benefit to your children or grandchildren by naming a trust the beneficiary of your IRA, even though the SECURE Act somewhat limited the effectiveness of this key tax planning tool.  If you have a large IRA or 401(k) (whether Roth or traditional), and you want to discuss stretching it out for as long as possible, BOOK A CALL with me to discuss more.

Reference: NJ Money Help (Nov. 2018) “Be careful when choosing a beneficiary”

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