Ask the Expert: Rule lowers benefits of IRA left to a trust

Does it ever make sense to leave an Individual Retirement Account (IRA) to a trust for named beneficiaries instead of directly to the beneficiaries? This was once the best way to leave an IRA to a minor, but is it still a good idea?

In most cases the answer is no. The reason: New tax rules.

Until recently, if you left your IRA to a trust for the benefit of a minor child, the trust could take annual required minimum distributions (RMDs) from the IRA based on the child’s life expectancy. The first RMD from a $1 million IRA based on a 5-year-old’s life expectancy is just $12,531, for example. Meantime, the money still in the IRA kept its tax-deferred status, and distributions that were promptly removed from the trust were taxed at the child’s low rate. Under these rules, a minor’s inheritance could grow dramatically.

But most IRAs inherited after Jan. 1, 2020 — including IRAs left to trusts — now must be emptied within 10 years of the original owner’s death. Under the new rules, if your grandchild inherits your $1 million IRA when he’s 5 years old, the account’s assets will all be subject to taxes by the time he’s 15.

“Everyone who has named a trust as their IRA beneficiary should review their plan and see if it will still work as intended,” says Ed Slott, a Rockville Centre tax accountant. “It probably won’t.”

A trust can still protect IRA assets for heirs who can’t handle money, who might squander their inheritance, or who may be vulnerable to lawsuits, he adds. But that protection comes at a very high tax cost. That’s the issue addressed in next week’s column.

The bottom line

A recent law has eliminated the tax advantages of leaving an IRA to a trust in most cases.

More information

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