🚀 We’ve raised $30M in Series A funding, led by GV (Google Ventures)!

What to Know About Naming a Trust as a Beneficiary of Your Retirement Account

14 min read
·September 6 2024
Share This
Everything you need to know about choosing a trust as a beneficiary of an IRA or 401 (K)

A critical part of estate planning is deciding how to distribute your retirement assets, such as IRAs or 401(k)s. You can name either individuals or a trust as beneficiaries of your retirement accounts. This strategy can offer certain benefits, particularly in terms of control and protection, but it also comes with potential tax implications and administrative complexities. That’s why those considering naming a trust as a beneficiary should approach the decision very carefully.

That said, the decision ultimately comes down to what your goals and priorities are. So it’s important to consider the potential benefits and disadvantages of naming a trust, and how that may affect your overall estate plan.

In this article, we explain all you need to know, including pros and cons of naming a trust for your IRA, to make the most informed decision you can.

What are the benefits of naming a trust naming a trust vs. individual as an IRA beneficiary?

There are a number of reasons why you may want to choose a trust as your IRA beneficiary. But, the main reasons are usually about exercising control over how the assets are distributed and to provide potential protection from creditors.

Here are a few reasons why it may make sense for you:

1. Control over the distribution of assets

If you have beneficiaries who are minors, have special needs, or lack financial responsibility, naming a trust provides more control over how retirement account assets are distributed. You can specify conditions in the trust, such as age milestones for access, specific uses for the funds, or annual withdrawal limits.

2. Protection from creditors or divorce

A trust can act as a barrier from potential creditors, lawsuits, or divorce proceedings. Naming a trust as the beneficiary can help prevent the funds being accessed in those types of situations.

3. Multi-generational wealth preservation

A trust can be used to help preserve assets from a retirement account for future generations, such as children or grandchildren, by staggering the distribution over many years.

4. Managing complex family dynamics

If you have a complex family dynamic, such as a previous spouse, children from previous relationships, or estranged family members, naming a trust as the beneficiary can ensure assets are distributed according to your wishes if there are any family disputes, rather than being distributed according to default state laws.

5. Centralizing asset management

Naming a trust can be part of a strategy to consolidate multiple types of assets under a single entity, making it easier for a trustee to distribute according to your wishes, as well as handle any other administrative tasks or investments. This may be particularly relevant for those with larger estates or managing multiple beneficiaries.

Even if any of these reasons are a priority for you, you should still understand the potential disadvantages of naming a trust before following through, if only to make sure you fully understand the decision and you’re not hit with any surprises.

What are the disadvantages of choosing a trust as your retirement account beneficiary?

The primary drawback of naming a trust as a beneficiary of an IRA or 401(k) mainly has to do with taxes. Trusts don’t typically enjoy the same tax advantages of an individual. For instance, it’s much easier for a trust to hit the top tax bracket—37%—than it is for an individual.

Here are some common disadvantages of naming a trust as a beneficiary of your retirement account:

1. Trusts have higher tax rates

Because trusts have more “compressed” tax brackets, they reach higher tax rates at much lower income levels than individuals—hitting the highest rate at just $15,200 of income. This risks reducing the amount passed onto the people named in your trust as beneficiaries.

It’s important to note, however, that there are ways to get around having the trust pay the taxes (more on this below).

2. Less flexibility

Once you name a trust as the beneficiary, changing it later could prove complicated—though not completely undoable. But, remember, trusts are legal entities that include special instructions and may have limited ability to adapt to beneficiary needs, law changes, or just your overall wishes, especially if it’s an Irrevocable Trust.

3. Risk of mismanagement by the trustee

A trust requires you naming a trustee, someone to oversee its management, including the distribution of funds and other administrative tasks. While a trust includes special instructions, some may not be “codified” and may be left as recommendations the trustee should follow but isn’t required to follow.

While the trustee should be someone you trust to manage everything, there is always the possibility that someone that’s inexperienced or has conflicted interests may not do so effectively.

4. It can introduce numerous complications

Naming a trust as a beneficiary, unlike a person, can complicate how funds are withdrawn and taxed. These rules vary by the type of trust, making it difficult for an inexperienced trustee to manage without help from professionals like attorneys, financial advisors, or tax experts..

Again, these are just a few potential drawbacks. It’s also important to dig into a bit more about taxes, withdrawal rules, and the impact of 2019’s SECURE Act.

How the SECURE Act of 2019 impacts naming a trust as a beneficiary

2019’s SECURE Act made major changes to inherited retirement accounts, with the IRS issuing its final regulations in 2024. These had some major implications on how One of the biggest updates is that many who inherit a retirement account would be subject to the 10-Year Rule and required minimum distributions (RMDs). This rule also applies to trusts in most situations. Here’s what you need to know about navigating these changes.

Loss of the “stretch” rule

Previously, most trusts could stretch retirement account distributions over a beneficiary's life expectancy. However, the SECURE Act now limits this period to 10 years, creating potential tax challenges.

Trustees face a decision: either spread withdrawals over the 10-year period or take smaller required minimum distributions (RMDs) annually and withdraw the bulk in the 10th year. Both strategies risk higher tax brackets because the IRA or 401(k) must be emptied by the end of the 10 year period.

In some cases, a 5-year rule may apply instead of the 10-year rule, which could present even greater tax disadvantages, depending on the type of trust.

When the 5-year withdrawal rule applies

The 5-year rule may apply in the following circumstances:

1. Non-designated beneficiaries. If you name a non-designated beneficiary, such as a charity or estate when the account owner dies before their RMD age, and the beneficiary does not qualify for the 10-year rule.

2. If the trust does not qualify as a “see-through” trust. A trust must meet certain conditions to be considered “see-through.” If not, the 5-year rule may still apply.

How to avoid the 5-year withdrawal rule

To avoid the 5-year withdrawal rule, the trust being named as the beneficiary of an IRA or retirement account must be considered a “see-through” trust. If it is considered a “see-through” trust, then the 10-year rule will apply, per the SECURE Act (again, the “stretch” rule would have applied prior to the SECURE Act).To be considered a “see-through” trust, it must meet four requirements:

1. The trust must be valid under state law.

2. The trust is irrevocable or becomes irrevocable at the death of the grantor (the person who set up the trust).

3. The beneficiaries of the trust are identifiable.

4. The trustee has provided the custodian of the retirement account with the trust document by October 31 of the year that follows the grantor’s death.

Once the trust has been established as the “see-through” trust, it must then be determined what the payout period is for the IRA based on the underlying beneficiaries. This depends on whether the trust is a conduit trust or an accumulation trust.

Here are the differences between the two:

Conduit Trust: This type of trust requires that all IRA distributions are paid directly to the trust beneficiaries. The IRS looks at the life expectancy of the beneficiary to determine RMDs, but under the SECURE Act, these distributions must still follow the 10-year rule in most cases.

Accumulation Trust: This type of trust allows IRA distributions to be retained in the trust for further management and control. However, the IRS considers the age of the oldest trust beneficiary to determine the applicable RMD period, which could also be within the 10-year window.

Why do these withdrawal rules matter?

The major disadvantage of the new 10-year rule is that it can have a significant impact on the trust’s taxable income, thereby risking reaching a higher tax bracket. If the trust is subject to the 5-year rule, it’s an even bigger disadvantage.

These new rules—the 10-year withdrawal period and mandatory RMDs—also apply to some individuals named as beneficiaries. We detailed some potential scenarios in another article.

However, they don’t apply to spouses named as beneficiaries. Another major advantage of naming a spouse is that they are able to roll over any inherited IRAs or 401(k)s into an account in their own name.

Can a person pay the taxes instead of the trust?

Trusts reach the highest marginal tax rate on income much faster than individuals. However, if the trustee distributes income to the trust’s beneficiaries, those individuals can report the income on their personal tax returns, potentially at a lower tax rate.

This approach is often possible with a Grantor Trust. In this context, however, the trust would not be considered a Grantor Trust since the grantor would be deceased. For other types of trusts, avoiding trust tax rates requires specific provisions in the trust agreement. The trustee must have the authority to distribute the trust’s income directly to the beneficiaries and issue a Schedule K-1 (Form 1041).

Trustees might choose this strategy when the beneficiaries' personal tax brackets are lower than the trust's tax brackets, optimizing tax efficiency. This decision must be weighed carefully, considering the beneficiaries' financial circumstances and any potential conflicts.

In such cases, the trustee can issue a Schedule K-1 (Form 1041) to the beneficiaries, allowing them to report the income on their personal tax returns.

These details must be correctly set up in the trust before it is named as a beneficiary to avoid unintended tax consequences.

So while it’s possible to avoid the tougher trust tax rates, doing so still involves nuances and potential complications. That’s not to say that it should deter you from this strategy but it’s important to understand the nuances and that it may be best to consult with an estate attorney when setting up your trust if naming it as an IRA beneficiary is your intention.

So should you name a trust as a beneficiary to your IRA or 401(k) or not?

There isn’t a right or wrong answer. As detailed above, there are valid reasons to name a trust as the beneficiary of your retirement account. And there are reasons you may not want to.

In most circumstances, it may be best to name a spouse as the primary beneficiary because they are not subject to the SECURE Act’s 10-year withdrawal rule or the mandatory RMDs. And they are able to roll over any inherited accounts into an account under their own name—meaning it’s not counted as taxable income.

Ultimately, the decision usually comes down to control versus tax and cost efficiency. If having control over how the retirement assets are distributed is a major concern and you care less about maximizing the amount, then naming a trust may make the most sense. However, if you want to maximize the amount that passes onto your beneficiaries and don’t mind there being less control over how those beneficiaries receive and/or use the funds, naming them directly likely makes the most sense.

Either way, it’s a crucial decision and one that should be made carefully. It’s always recommended that you work with your financial advisor or a tax professional to approach the decision that makes the most sense for you and your situation.

Share This

Other Categories

  • Trends & Insights

    Innovative perspectives from wealth management industry leaders.

  • Product & Company Announcements

    Get the latest updates about wealth.com's product offerings.

  • The Practical Planner Podcast

    A podcast for advisors about delivering more effective Estate Planning.