Trust as IRA Beneficiary? Avoid these Mistakes

by Prof. Robert Bloink and Prof. William H. Byrnes

A laundry list of reasons to avoid naming a trust as an IRA beneficiary exist. The existence of trust beneficiaries tends to increase the complexities that already exist when the IRA funds pass to its beneficiary upon the original account owner’s death. Naming a trust as beneficiary could even lead to higher future tax liability—because trusts become subject to the highest federal income tax rate at a much lower income level. Still, there are some situations where naming a trust as IRA beneficiary does make sense. Before deciding to name a trust as beneficiary, the client should have a clear understanding of the rules, both with respect to taxes and required minimum distributions (RMDs)—and have a strong rationale for naming a trust as beneficiary.

Rules Governing Trust Beneficiaries: Taxes and RMDs

The tax treatment of the actual IRA funds will depend on the type of trust that is used. If the trust is an accumulation trust (meaning that the funds are distributed to the trust and remain within the trust), the distribution is taxed at the trust’s tax rate. The 37% rate bracket will kick in once the trust has income of only $15,650 in 2025.

If the trust is a conduit trust that passes the distribution directly through to the trust’s beneficiary, the human beneficiary is taxed at their own ordinary income tax rate (in 2025, the highest rates apply to income above $626,350 for single filers and $751,600 for joint returns). Obviously, depending on the trust structure, the tax liability could be much higher when a trust is named beneficiary.

With respect to RMDs, very briefly, trusts are legal entities that are subject to the RMD rules that apply when a non-human inherits the account. Aside from a lump sum distribution option, a trust or estate beneficiary has two options for emptying the account: a five-year distribution period or a life expectancy method.

Different RMD rules apply if the trust-beneficiary qualifies as a see-through (or “look-through”) trust. When a trust qualifies as a see-through trust, the trust itself is “looked through” and the assets pass directly to the trust’s beneficiaries. If the trust qualifies, the RMD rules that apply to the inherited account will depend on the identity of the beneficiaries. In other words, the ten-year rule or life expectancy rule may apply, depending on the facts.

Reasons in Favor of Naming a Trust as IRA Beneficiary

Trusts as beneficiaries can be useful in blended family situations. The owner may wish for their surviving spouse to enjoy the benefit of the IRA funds during their lifetime but then wish for the remainder interest to be passed to children from a previous marriage. A properly structured trust can serve to ensure that both wishes are accomplished.

The identity of the beneficiary can have a significant impact on whether a trust is a smart idea. If the owner’s beneficiary is a minor child, a trust can provide substantial value. The minor cannot legally control the IRA funds. Naming a trust can both allow for management of the trust while the beneficiary is a minor and control over the account’s funds once the beneficiary turns 18.

Similar concerns apply if the owner suspects that their desired beneficiary would be particularly vulnerable to scams that target individuals who have received large inheritances. The trust structure can ensure that the funds are properly managed and don’t fall into the hands of bad actors.

A special needs trust that complies with post-SECURE Act rules can be necessary and beneficial—both to preserve the special needs beneficiary’s right to government funds and to take advantage of the “stretch” tax treatment. Post-SECURE Act, only eligible designated beneficiaries may use their own life expectancies to "stretch" distributions over a lifetime. Chronically ill beneficiaries and disabled beneficiaries are classified as eligible designated beneficiaries, so that the lifetime stretch remains available.

Federal law does not provide for creditor protection for inherited IRAs (currently, up to $1,711,975 in IRA dollars are protected under federal law, but that protection does not extend to inherited IRAs). While state protections may apply, clients with asset protection concerns may wish to establish a trust to protect the funds from the beneficiary’s creditors.

Additional beneficiary characteristics can also be relevant. If the owner is worried about a beneficiary’s gambling problem, for example, or wants to ensure the funds remain the beneficiary’s separate property in case of a divorce, the trust can provide protection.

Conclusion

From a tax perspective, naming a trust as IRA beneficiary can have unintended—and often unexpected—consequences. A properly structured see-through trust, under the right set of circumstances, can provide the original account owner with much-needed peace of mind.  It’s always critical that the client understand the pros and cons of the trust structure when making the decision.