Recently this blog touched on some of the issues related to leaving an individual retirement account to your heirs in a will, as found here. There are many options that people have to leave their IRA to others in a will. If you are leaving your IRA to heirs in your will but want to also put some protections in place regarding that IRA, leaving the IRA to a trust may be the best option. You may want to leave the IRA to a minor or to insure that the benefits of your IRA are not able to be attached by creditors. Even if your intended heir is not in need of spendthrift protections, there may still be a need to protect the IRA (and other money or property in the will) from creditors of the heir just the same.

While inherited property is generally excluded from equitable distribution in a divorce, it can still be considered income for purposes of alimony. Certain protections in the form of allowing a trustee to cut off the flow of money from the trust will insure that the beneficiary will not have to worry about this issue. Trusts are very flexible, which can allow you to build certain protections into the trust, such as choosing the trustee and giving them a free hand on distributions. If you leave the money to your heir in a will, unless the heir is a minor, in which case you will likely leave the money to a guardian, you have limited ability to insure that there will be protections put into place, since a will passes property or money outright, while a trust insures that there will be rules in place to protect the distribution of that money or liquidation of the property.

Leaving money to a trust is treated by the IRS, in many ways, as leaving money to the heir directly. More specifically, the IRS looks through the trust to determine the age of the beneficiary, which in turn determines the required monthly deduction. When Congress setup the tax benefits of IRAs, they wanted to make sure that these monies would not sit in an IRA indefinitely, accruing income without distribution. As such, when the creator of the IRA passes away or reaches the age of 70 1/2 failure to withdrawal money on a monthly basis will incur financial penalties.

The IRS has four general rules to allow for the tax benefits to continue under an inherited IRA to pass to a trust:

  1. The trust must be legally valid under local state law; and
  2. The trust must be irrevocable at the death of the plan owner; and
  3. Documentation must be timely given to the plan custodian; an
  4. The beneficiaries must be ascertainable from the terms of the trust documentation.

There is finally the option to leave channel the monthly distributions into a second trust, called an accumulation trust. More on that in another blog posting.  The last consideration that needs to be addressed is that the payout or distribution of the IRA will be determined by the age of the oldest beneficiary.

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