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May 12, 2011
Q. We have been working on funding our trust and changing beneficiaries of our IRAs. Our new IRA custodian says that we should name our spouses as beneficiaries first and the Trust second. Otherwise, the custodian says that we’ll suffer a big tax hit upon death. This is contrary to the instructions you gave us.
A. As a Sacramento estate planning attorney, I run into this question all the time. You would only take a big tax hit if your trust was not properly drafted to qualify as a “designated beneficiary.” Your trust qualifies so there is no tax hit in sight.
I prefer to have you name the trust as the primary beneficiary so that the surviving spouse can take advantage of a planning opportunity when the IRA owner dies and there is better clarity about his or her financial situation and the tax laws. If the spouse is named as the primary then this planning opportunity evaporates because the beneficiary designation is never looked at again.
If the surviving spouse determines that it provides more flexibility to have the IRA roll directly to them, then as trustee of the trust they can say “no thanks” – a legal disclaimer and the account rolls to the next beneficiary, which is of course the surviving spouse.
By the way, the IRA custodian is correct that in certain situations naming a trust can result in a big tax hit. If the trust that does not follow the “designated beneficiary” rules, a faster payout will be required – either as one lump sum or at most over 5 years. Whenever a payout or distribution is made from the IRA the income taxes are due at that time. Making sure your trust qualifies as a designated beneficiary means that the IRA custodian can “look through” the trust to the people and stretch the distributions out over the life expectancy of the trust beneficiaries.
Have a question for Heather? Feel free to submit your questions and feedback here or call our office at (916) 241-9661 to set up a complimentary Peace of Mind Planning Session with the mention of this article (normally $750).
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