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If you have an IRA or other retirement plan, you will be handed a form in which you are asked to designate a beneficiary to receive your retirement benefits upon your death.  There may also be a space where you can name a contingent beneficiary or beneficiaries in case the primary beneficiaries has predeceased you. 

There are two goals in deciding who to name as beneficiary.  The first is for tax reasons in that the IRA proceeds can be “stretched” over the life expectancy of the beneficiary(ies).  This defers the income tax “hit” for as long as possible and ensures a steady income stream of funds for your beneficiaries over their lifetime(s).   The second goal is to avoid probate – if no one is named as beneficiary of your plan, the proceeds will pass to your estate and will need to be probated.

For most families, the primary beneficiary will be your spouse, with the children named as secondary beneficiaries.  Sometimes, however, there are reasons to prevent beneficiaries from receiving the funds directly.  For example, if you leave your IRS directly to your child, s/he will have the option to cash the money out all at once.  Not only will this lose the benefit of the stretch out of your “required minimum distributions” (“RMDs”) but 100% of the amount withdrawn will be included in your child’s taxable income in the year of withdrawal. 

The problem gets worse if your child is a minor.  On that case, there will have to be a guardianship established by the court to manage the IRA until the child reaches 18.  And when s/he reaches 18, s/he can still take the remaining amount out in one lump sum!

If, on the other hand, you establish an IRA trust to receive the funds upon your death (or the death of your spouse), you can ensure that the RMD’s are stretched over the lifetime of each of your beneficiaries and the trust can be structured so that distributions are restricted in case any of your children run into financial or marital difficulties.

The IRA trust itself comes in 2 alterative models: the first is one set up as part of your living trust; the second is a “standalone” Trust which you establish during your lifetime but is only funded upon your death.  For a discussion of which is the better, see "LINK: IRA Trust: Standalone or Living Trust.” Our strong recommendation is that you choose a standalone trust for IRAs larger than $200,000.

The main advantage with the IRA trust is that you can control how the money is paid out within the trust to the beneficiaries.  For example, you can direct that the trust pay income to your spouse for his/her lifetime, and upon his/her death, the funds can go to your children.  You can allow the trustee to withdraw more money if needed for emergencies.

The disadvantage with the IRA trust is that setting one correctly can be quite complex.  For example, you need to make sure that the trust is written to follow strict IRS guidelines known as “conduit” or “see-through” rules.  Also, many trusts pay income taxes at a higher rate so the trust must allow the trustee to pass all the IRA distributions out to the individual trust beneficiaries.  Finally, if you leave your IRA in a trust for your spouse, she will have to draw down the IRA every year over the life expectancy of the oldest beneficiary.  In contrast, if you name your spouse outright as beneficiary, s/he can roll the IRA into his or her own IRA – and possibly defer distributions and taxes for many more years.

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