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Ask the Expert: Leaving an IRA to a grandchild, part 2 of 2

I want my young grandchild to inherit my Individual Retirement Account. To ensure that it's protected from his mother's creditors, can I leave the IRA to a trust in his name?

Yes. You can create the trust in your will and leave it unfunded until your death. But if you want to prolong the IRA's tax-deferred status for your grandchild, the trust must comply with Internal Revenue Service rules.

Here's why: All IRA beneficiaries must take annual RMDs — taxable minimum distributions — from their inherited IRA. A human beneficiary can stretch those RMDs over his or her life expectancy, letting the IRA balance continue growing untaxed. But a trust has no life expectancy, and therefore must empty the IRA much faster.  

The solution is a "pass-through" trust, whose trustee can take RMDs based on the life expectancy of the trust's human beneficiary — e.g., your grandchild. Distributions that are promptly removed from the trust are taxable at the child's tax rate. (If they accumulate in the trust, they'll be taxed at a much higher rate.)

To qualify for pass-through status, a trust must be valid under state law, irrevocable, and have human beneficiaries. A copy of the trust document must be given to the IRA custodian by Oct. 31 of the year after the IRA owner's death.

Last but by no means least: Make sure you name this trust as your beneficiary on your IRA beneficiary form, says Ed Slott, a Rockville Centre tax accountant — e.g., "Trust for the benefit of Andrew Jones under Article 7 of my will."

"Even a 'pass-through' trust that's perfectly written won't work as you planned if it isn't named on the IRA beneficiary form," Slott says.

The bottom line

A 'pass-through' trust prolongs an IRA's tax-deferral for a minor beneficiary.

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