Using a Trust as a Beneficiary of an IRA

source (1)

The IRA is one of the most significant retirement vehicles in America. In fact, the Investment Company Institute (ICI) reports that as of 2021’s third quarter, U.S. investors held more than $13 trillion in IRA accounts. That’s more than all defined benefit (pension) plans in the US combined.[1] However, the IRA is also an elaborate and tax-sensitive asset for estate planning and wealth transfer purposes. Coupling it with a trust, another complicated vehicle, can make it especially intricate. Investors must plan carefully when naming a trust as the beneficiary of their IRA.

Using a Trust

A trust has three parties: The grantor who creates the trust, the trustee who manages and administers over the trust, and the beneficiary who gets the use of the trust. Trusts are commonly used in estate planning situations since it allows the grantor to exhibit some control over what happens to their money after their passing.

Grantors can use trusts to ensure that their surviving spouse doesn’t disinherit their children from a previous marriage, for example. Or to protect a spendthrift child from blowing their inheritance. Trusts can also help mitigate estate taxes and even help provide for special needs children who may not be able to care for themselves. The applications are broad.

When it comes to IRAs, trusts are used to direct and control the flow of money following the original owner’s passing.

Its posthumous, not inter vivos

IRAs must have a natural person as their owner. Trusts, businesses, corporations, and anything else not explicitly human won’t qualify. Having a trust as owner during your lifetime is not possible. But the IRS has allowed a workaround at death. A trust can be named as an IRA beneficiary if it meets the requirements for a “see through” trust as outlined in Treasury Regulation 1.401(a)(9)-4. Namely, that:

  • It is valid under the laws of the state in which it is domiciled
  • The trust is irrevocable or becomes irrevocable upon the death of the original IRA owner
  • The trust’s beneficiaries are all eligible to be designated beneficiaries themselves, and
  • A copy of all trust documentation sent to the IRA custodian by Oct. 31 of the year following the IRA owner’s death.

Bullets 1, 2, and 4 are pretty straightforward. But bullet three is a little convoluted.

Designated Beneficiaries and Stretch IRA Provisions

A designated beneficiary just means that you can identify and name the person. This could be someone specific like a friend or family member or an entire class of people, such as all your children or grandchildren. In either case the person is easily identifiable and known. What it can’t be is vague or open ended as in “whomever my trustee decides”.

The trust can serve as beneficiary if all four of the see-through conditions are met.

The three types of beneficiaries

The IRS breaks down IRA beneficiaries into three categories: Eligible Designated Beneficiaries, Non-Eligible Designated Beneficiaries, and Non-Designated Beneficiaries. Only the first in that list qualifies to stretch distributions over their lifetime(s). These include minor children of the decedent, disabled persons, those who are chronically ill, spouses, those who are not more than 10 years younger than the decedent, and some trusts.

Non-eligible designated beneficiaries are subject to the SECURE Act’s new 10-year rule, which states that the full IRA balance must be withdrawn within 10 years of the decedents passing. Non-spouses at least 10 years younger than the decedent (usually kids and grandkids) and certain trusts fall into this category.

Non-Designated beneficiaries are the last category and include charities, your estate (i.e. your will), and some trusts. This class must distribute IRA proceeds within five years if the decedent had not reached the age for required minimum distributions. Distributions can be stretched over the decedent’s life expectancy if they had.

The classes of beneficiaries are important because a single trust may name multiple beneficiaries, and potentially at least one from each class! That’s three separate sets of distribution rules for a single pot of money. So how does the trustee determine which set of distribution rules to follow?

Conduit vs. Discretionary Accumulation Trusts

The answer depends on the kind of trust used. A conduit trust passes distributions from the IRA to the trust, and then from the trust to the beneficiaries. The decedent can set it up to allow the trustee to stretch distributions or pay everything out all at once upon a beneficiary’s request. The requirement for these trusts is that all income must be paid out as it is received! Conduit trusts cannot hold onto any of the income the IRA produces.

The end beneficiary is responsible for all taxes with conduit trusts. This is because the trust doesn’t retain any income, so there is nothing to tax at the trust level!

Conduits also do not allow beneficiaries to be changed. This can be an important feature for people who have remarried. A conduit trust can name a surviving spouse to receive all income while the grantor’s children get whatever’s left. The trust ensures that these parties don’t change. Leaving an IRA directly to a spouse would allow them to roll it into their own IRA and select their preferred beneficiaries.

Accumulation Trusts

Accumulation trusts work slightly differently. They provide the trustee the flexibility to hold onto IRA distributions to the trust. They aren’t required to pass them directly through to the end beneficiary like a conduit trust. Assets can sit there in the trust and accumulate (hence the name). There is also no time limit for the trustee to disburse funds.

This has some advantages. Assets that stay in the trust are protected from creditors for example. A child that is going through a divorce, bankruptcy, or other financial problems won’t be a liability. Their inheritance will be safe in an accumulation trust.

These trusts can also help protect spendthrift children from financial self-harm. Trustees are under no obligation to pay out funds. They could wait until an 18-year-old beneficiary turns 30. The desire to buy a frivolous car might have dissipated by then. Or they can hold onto funds if they know a beneficiary is battling an addiction issue like gambling.

But these trusts have drawbacks as well. Trust tax rates are compressed. The top 37% bracket starts at just $13,450 of income! And these trusts must pay tax on any income they hold onto. Conduit trusts hold no money and therefore pay no tax. But accumulation trusts hold some or all of the money and therefore pay some or all of the tax. There’s more on how this plays out below.

Mix-and-Match Beneficiaries

Conduit Trusts

Trustees need to be careful to follow the right distribution rules when they have different classes of beneficiaries. This is easy with conduit trusts. Only the income beneficiary matters per Treasury Regulation 1.401(a)(9)-5, Q&A-7.

The income beneficiary is the one who gets all of the income from the trust. The remainder beneficiary gets whatever is left. Its common to name a surviving spouse as the income beneficiary and kids or grandkids as the remainder beneficiary.

This means that the trustee just needs to determine whether the income beneficiary is eligible designated, eligible non-designated, or non-designated to figure out which distribution schedule to use. Multiple income beneficiaries are somewhat more problematic.

Remember that eligible designated beneficiaries can stretch distributions over their lifetime. This is different from a non-designated beneficiary that can stretch over the decedent’s remaining lifetime in certain situations. If multiple income beneficiaries are named and both are eligible designated beneficiaries, then one can make a strong argument that the oldest beneficiary’s lifespan will be used as it is the least favorable.

But this isn’t steadfast. The passage of the SECURE Act in 2019 complicated conduit trusts and have added some ambiguity as to how best to treat multiple income beneficiaries. More on that below.

Accumulation Trusts

The rule for accumulation trusts is to look at all beneficiaries and select the most onerous schedule. This could be as short as five years if a charity is listed as a beneficiary anywhere in the trust.

For example, a trust could name the surviving spouse to get income for life with any remaining assets going to the decedent’s child and church. The payout schedule for the spouse is lifetime, is 10 years for the child, and is just five years for the church (assuming IRA owner died after age 72). The trustee must use a five-year distribution schedule since they are required to use the least favorable distribution schedule of any beneficiary!

The only exception for this is an Applicable Multiple Beneficiary Trust. This is a carve out for a special needs or chronically ill individual. It allows them to stretch distributions over their lifetime when it normally would have been paid out under a shorter distribution schedule.

Issues with Multiple Income Beneficiary Conduit Trusts

We see these most commonly with blended families in our practice, especially when the couple has unequal retirement savings. These trusts can ensure that a surviving spouse is cared for during their lifetime with any remaining assets ultimately passing to kids and grandkids.

But the passage of the SECURE Act in 2019 complicated these trusts significantly. Multiple income beneficiaries can still leave some ambiguity on how to treat distributions. Some practitioners argue that trust shares can be created for each income beneficiary under a ‘master trust’ type of arrangement. Each designated eligible beneficiary could then stretch distributions over their lifetime as opposed to the lifetime of the oldest beneficiary. This author is personally skeptical about that.

Congress went to great lengths to specifically carve out provisions for special needs beneficiaries when a master trust is named as the IRA beneficiary. It doesn’t seem likely that all sub trusts would subsequently qualify for carve out treatment given this.

Conduits trusts have been able to use multiple income beneficiaries for years when the eldest beneficiary’s life expectancy was used to determine the applicable payout. It’s possible but would be somewhat odd for the IRS to suddenly interpret that differently. I believe this will be the more likely scenario but additional clarification from the IRS is needed.

The best remedy for all of this may simply be to name a single eligible designated beneficiary of the trust when a lifetime stretch option is desired. Multiple income beneficiaries could therefore merit multiple conduit trusts.

Additional complications to conduit trusts stemming from the SECURE Act

Non-eligible designated beneficiaries, usually kids and grandkids, must get a full disbursement within 10 of the death of the original IRA owner or the death of the income beneficiary. The IRS dictates how slowly money must come out. But the trust’s own language may clash with this.

For example, a conduit trust may contain language to the effect of:

“The trustee will withdraw only the required minimum distribution from the retirement account each year. All such amounts will be distributed to [insert beneficiary name] as soon as administratively feasible.”

This may not sound like much, but what happens when it isn’t clear that a distribution needs to happen in the first place?

The ‘ALAR’ Rule and Eligible Non-Designated Beneficiaries

New guidance from the treasury department has clarified at least one aspect of the SECURE act. It was previously thought that the 10 year rule for Non-eligible designated beneficiaries was simply to pull out everything by the end of the 10th year. It didn’t matter how much came out or when as long as it was all gone at the end of year ten. This is no longer the case. The IRS is applying the At Least As Rapidly, or ALAR, rule in addition to the new 10-year rule.

The ALAR rule requires IRA beneficiaries to continue taking distributions at least as rapidly as the method being used by the original IRA owner. This means that that if the original owner hit their required beginning date at 72 and began required minimum distributions, then the beneficiaries must also continue to take out income under the same method (i.e. ‘stretch’ over their lifetime just like the original owner).

Non-designated beneficiaries will therefore have to take an annual required minimum distribution as well as drain the full account by the end of year ten if the original IRA owner died after age 72. This effectively works out to regular distributions in years 1-9 following by a giant distribution of whatever is left in year 10.

But the ALAR rule only applies for IRA owners who reach their required beginning date at age 72. It will be just the 10 year rule for non-eligible beneficiaries that inherit from IRA owners who pass away before then.

The Special Case for Roth IRAs

Roth IRAs are unique. They do not have a required beginning date (RBD) because they do not have required minimum distributions during the original IRA owner’s lifetime! This means that anyone who dies and leaves a Roth IRA behind is therefore assumed to have died before their required beginning date. And since the ALAR rule only applies to those who hit their RBD, the rule is effectively moot for Roth IRAs!

Only the ten year distribution rule applies for non-eligible beneficiaries of Roth IRA accounts.

Tying it back together with Conduit Trusts

Try taking the sample trust language from above and applying it to a Roth IRA. No distributions are required until year 10 under the 10-year rule. The trustees’ hands are tied. They can’t functionally make a distribution for a decade given that language! The same would be true if that trust language were applied to an IRA whose owner died before their required beginning date.

But the real life act of updating trusts to reflect this is even more cumbersome. The IRS provided initial guidance in March of 2021 that suggested the ALAR rule would be applied. Then if backtracked on that in May of the same year. It wasn’t until February of 2022 that it flip-flopped once again in re-applying the ALAR rule. Carmichael Hill & Associates doesn’t offer tax or legal advice, but working with an attorney to draw up broader provisions may be a good bet. There could be more flip-flopping ahead.

But even with these problems solved, the conduit trust still doesn’t offer any creditor protection to the remainder beneficiaries after year 10. And given that many people set these up to put at least some kind of barrier in between the money and the end beneficiary, accumulation trusts should be given a hard look.

Real Life Challenges with Accumulation Trusts

Any accumulation trust that finds itself subject to the 10-year distribution rule will inevitably encounter tax issues. The top federal rate of 37% starts at just $13,450 in 2022. That threshold also triggers the top capital gains rate of 20% as well as an additional 3.8% on all investment income due to the Net Investment Income Tax.  Add state and local taxes to the mix and the trust could well be paying half its income or more to taxes.

But these trusts may actually get more popular despite the punitive taxes. Recall that a conduit trust must pay out over a period of just ten years. The original IRA owner may not feel its worth the time or expense to create a conduit trust given the short payback period. This is especially true if the trust was established primarily to protect a beneficiary.

But these trusts can actually become relatively tax efficient after the initial ten year period. The grantor could allow the trustee to hold all income for the first decade. The principal of the IRA is effectively transferred into the trust over this period less taxes. The trustee could choose to simply distribute all annual income after year 10. The trust would pay no tax since it retains no income. The beneficiaries get money as intended by the grantor and the trust principal remains protected from creditors!


Ultimately, a decision to name a trust as an IRA beneficiary is a decision to protect your beneficiaries. Conduit trusts will offer limited protection due to the 10 year payout rule. Accumulation trusts are more favorable in that respect but come at a far greater cost (taxes). But the benefits of either of these shelters can be undone if the trust beneficiaries aren’t structured correctly.

For that reason, it may be worthwhile to set up multiple trusts. Or split the IRA beneficiaries between a trust benefitting one individual and direct payments to others. This is especially true for charitable beneficiaries. They need neither the tax benefits from stretching out distributions and rarely the creditor protection.

Whatever the situation, the time for conversations about using trusts as an IRA or Roth beneficiary is now.


[1] ICI. Retirement Assets Total $37.4 Trillion in Third Quarter 2021. December 16, 2021.

The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but is intended to help manage risks and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax, or financial advice. Please consult a legal, tax, or financial professional for information specific to your individual situation.

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