IRA Trusts How to Keep Your Kids from Spending it All At Once

Mother and daughter putting money in a piggy bank

By Andrew C. Grant

With estate taxes no longer a concern for most Americans attention should turn to the more practical aspects of estate planning, including what to do with large, income-tax producing assets like retirement accounts. Depending on the family dynamic, how an IRA or other retirement account passes can have significant practical or income tax-related consequences. In many families, the traditional beneficiary arrangement will suffice; that is, each spouse designates the other as the primary beneficiary of the IRA and the children are backup beneficiaries. This allows the survivors to draw out the IRA distributions as long as possible and minimize taxes. Minimizing taxes isn’t always the primary goal, however. In some families, there are concerns about a child’s ability to manage money. In others, it’s a second marriage for one or both spouses, and they want to make sure their own children ultimately benefit from the IRA, not the stepchildren. Both situations can be addressed by using an IRA trust; an accumulation IRA trust for the child who can’t handle money, or a conduit IRA trust for the surviving spouse with stepchildren. The accumulation IRA trust allows the trustee to distribute only so much of the IRA funds as the trust’s terms allow. It can be generous or allow for only the bare necessities. The downside is that the trust must take regular IRA distributions and pay income taxes on them, and it must do so based on the life expectancy of the oldest possible trust beneficiary. For example, if the primary beneficiary is only 30 when the IRA owner dies, but a backup beneficiary is 50, then the IRA must be drawn down based on the 50-year-old’s life expectancy. A conduit IRA trust, by contrast, must distribute the required minimum IRA distribution to the primary trust beneficiary each year. This works well for supporting the surviving spouse while eliminating the risk that the deceased spouse’s children will be cut out. The downside is that the surviving spouse cannot roll the IRA over and treat it as her own to calculate the minimum distribution. Rather, the IRA must be distributed over the surviving spouse’s life expectancy, whether or not the spouse has reached retirement age. For example, if the surviving spouse is 60-years old, then the IRA must distribute benefits to the trust each year even though the spouse has not reached age 70 1/2. The surviving spouse cannot change the terms of the IRA trust, however, and upon that spouse’s death the IRA owner’s natural children would inherit depending on the trust’s terms. An IRA trust’s terms can be customized to fit the family situation, whatever it may be. The key is to determine what the goal is, whether it’s protecting the family from itself or maximizing the income tax benefits of the IRA. Once the goal is known, the rest is just a matter of planning how to get there.