Most people will name an individual as IRA beneficiary. In some cases, though, you’d prefer to have your IRA pass to a trust.
You might want a minor grandchild to receive your IRA, or you’re afraid your heir will mis-manage the direct inheritance of a large IRA. In such situations, you’d name a trust as IRA beneficiary and also name the intended recipients as trust beneficiaries.
A recent ruling indicates the IRS’ position on trust beneficiaries. Say you name a trust with your spouse as beneficiary. Your children and your grandchildren are named as contingent beneficiaries while a charity is named to receive the remainder, after the death of all these beneficiaries.
If the trust does not contain the right language the IRA may have to be distributed over the shortest life expectancy among all the beneficiaries. In this example, that would be the charity, which has no life expectancy. Your IRA would fall under a “five-year rule,” requiring complete distribution within five years, causing a substantial loss of tax-deferred growth.
To avoid this problem, make sure a trust you name as IRA beneficiary is a “conduit trust.” With a conduit trust, every dollar that goes from an IRA into the trust must be immediately paid out to the trust beneficiaries, under the terms of the trust. This approach will keep the contingent and remainder beneficiaries from being included, for purposes of calculating life expectancy, and extend your IRA’s tax deferral.