Today, we’re going to talk about IRA trusts. These are a way to literally protect the beneficiaries from themselves and control how they get money. There’s two main types of IRA trusts: an accumulation trust and a conduit trust. An important aspect of both these trusts are if you’re leaving an individual retirement account, an IRA, with a beneficiary of this trust, the trust has to be written in a specific manner and have specific beneficiaries that have life expectancies or this will fail and create severe tax consequences. Now, the conduit trust is an IRA trust set up with named beneficiaries, and what happens is in typical fashion, when the IRA pays out to this trust, the trust looks for the oldest beneficiary and the payouts from this trust are based on the oldest beneficiary’s life, their lifespan according to the IRS.
So what happens is the required minimum distributions are paid out according to that lifespan. One of the things this does is it prevents whoever the beneficiaries are from taking all the IRA inherited in one lump sum. It prevents them from taking it within five years and forces them to space it out over their lifespans so they don’t blow the money fast. You’ve worked your entire life saving it. They don’t need to spend it in the next few years. They can take some time to spend it. But with this trust, since it’s conduit trust, the IRA is really only taking in the required minimum distributions and then pushing them out to the beneficiaries. It doesn’t accumulate or hold anything. The Beneficiaries are taxed on the required minimum distributions and there’s no taxable income within the IRA trust.
The IRA accumulation trust is a trust designed to somewhat protect the beneficiaries from themselves. If they have an addiction, if they’re big spenders, they’re wasting a lot of money. You know if they get the RMDs, they’re going to spend it as fast as possible. With the accumulation trust, you can make it so there’s a trustee that receives the money from the individual retirement account, the IRA, and then once it’s getting the required minimum distributions from the IRA, what happens is the trust has the option to pay out the entire required minimum distribution to the beneficiary or just a portion of it, maybe just for education until they’re 25 or 30, maybe after that just for health support and maintenance for certain items up until they’re 35 or 45. It all depends, but what happens is since it’s accumulation trust, it can accumulate. The RMDs go into the account, and then rather than going directly to the beneficiary, they accumulate in the trust.
A big problem with this is trust tax rates are very punitive. Once you get above $12,000, the tax rate is over 30%. It’s much more progressive than an individual’s tax rate. So this is something you’d want to use when you really want to protect your beneficiaries from themselves if they have an addiction, if they’re big spenders, anything like that, you just want to protect them from just wasting all the money that you’ve spent a lifetime saving in that IRA.
If you have any questions about IRA trusts, how they can be used, why they might be beneficial for you, you can set up a consultation on my website or call my office (802) 442-9800.
William C. Deveneau is an attorney practicing in Southern Vermont, including Bennington and Manchester, and New York, including Albany, Colonie, Hoosick Falls, and Troy.