What is An IRA Trust? Learn Whether It's Right For You

Struggling to feel confident about the future of your IRA? It's time to talk trusts.

You've spent your career building your IRA, and it's important that you are comfortable that your assets will be allocated responsibly. While you're in control of your IRA today, you want to be just as certain that your savings will be respected once you're no longer the account owner.

Today, more and more financial advisors and estate planning attorneys are recommending that clients name an IRA trust as their beneficiary, rather than selecting individuals. If you are concerned about the heir's financial instincts, existing or potential future debt, or other components related to their finances, an IRA trust will allow you to sleep soundly.

How can you arrange the trust so that you feel secure (both today and tomorrow)? We've laid out the details of the process below.

How Do IRA Trusts Protect Your Assets?

Simply put, an IRA trust prevents a named heir from receiving the funds outright after the owner’s passing. The account owner can place additional stipulations on the IRA to ensure that the heir treats the money as expected.

An IRA trust can be the beneficiary for both a 401(k) and a Roth IRA.

Why are more estate planning attorneys recommending IRA trusts? Because a 2014 Supreme Court ruling brought this issue to a head. In Clark v. Rameker, the Supreme Court ruled that inherited IRAs would no longer be treated as protected assets in bankruptcy. This means that creditors can gain access to those funds if the heir possesses debt.

Are there Illinois-specific laws concerning IRA Trusts?

Illinois, like most other states, does not provide protection for inherited IRAs. That is established by case law in Illinois as well as federal law.

Should You Set Up An IRA Trust?

If you have a large IRA and concerns about its beneficiary or beneficiaries, you should absolutely meet with an estate planning attorney to learn more about IRA trusts.

Past that, there are a few important factors to consider. You should determine the costs that will be involved in creating and maintaining a trust, and weigh them against the benefits of protected assets and the risk of your IRA being abused after your passing.

Make these your guiding factors:

  • Account Size - If your IRA is at a half million or above, you should take action to protect your assets. Lawsuits, divorce and bankruptcy can all threaten an inherited IRA. When a trust is in place, a professional trustee distributes assets to the beneficiary. The heir doesn’t have control over the money, and the trust operates as a protective layer.

  • Life Situation / Personality of Heir(s) - If the heir is a minor, you should take care to ensure that they don’t gain access to the IRA until they are of a responsible age. There is also the potential for heirs to struggle from personal problems like substance abuse or debt that make them more likely to misuse the funds. If you’re worried, a trust could be the right course of action.

How To Set Up an IRA Trust

Speak with your estate planning attorney to begin the process. If you are already using trusts in the planning of your estate, this process will be fairly straightforward.

There are two types of IRA trusts to consider:

  • Conduit Trust - Distributions bounce from the IRA to the trust to the beneficiary. The money is taxed at the beneficiary’s rate.

    • When is it ideal? This trust is more straightforward and simpler to set up. All distributions must be immediately distributed to the primary beneficiary or beneficiaries, so they are not as protected as if they were kept in the trust.

  • Accumulation Trust - The trust receives distributions from the IRA, but does not immediately distribute it to the beneficiary. Distribution is taxed at the trust’s income rate with a maximum rate of 39.6%.

    • When is it ideal? The assets within this type of trust have more protection against creditors. The beneficiary or beneficiaries can also maintain SSI or Medicaid eligibility. At the same time, the trust is a separate taxpayer and is subject to the compressed income tax brackets. There is also a greater risk of the trust not being a designated beneficiary because all beneficiaries (including contingent beneficiaries) need to be considered.

The IRS does permit a toggle from conduit to accumulation trust that can be used once per IRA trust. This allows for accommodation of a change in circumstances related to the beneficiary and can be used between the time the trust was set up and September 1 of the year after the owner’s death. This power can be given to the Trust Protector at the time of trust creation.

An important point to remember: beneficiaries’ names on financial accounts (IRAs, insurance policies, brokerage accounts, etc.) supersede what is dictated in your will. It’s crucial that you keep those names up to date.

Confer with your estate planning attorney as to whether a conduit trust or accumulation trust would be more appropriate for your priorities and assets. Perkins & Zayed offers complimentary consultations so that we may learn more about your needs and recommend the best course of action - reach out today to schedule yours.