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Irrevocable trust as IRA beneficiary is a problematic choice

My IRA beneficiary is an irrevocable trust. Should I change this? Do the same rules apply as when an estate is the beneficiary?

For maximum tax benefits, it’s always best to make a human being your IRA beneficiary. But a trust may be necessary if your heir is a child, or an adult who’s unable to handle a big inheritance. In that case, a trust that meets IRS requirements can preserve the IRA’s tax advantages for your heirs.

IRA distributions are taxable whether your beneficiary is a trust, an estate, or a person; and all beneficiaries must take distributions from an inherited IRA. But human beneficiaries can stretch those distributions over their life expectancy, boosting their inheritance by prolonging its tax-deferred growth. For example, if your 40-year-old daughter inherits your $500,000 IRA, takes required minimum distributions based on her life expectancy, and lets the balance continue growing tax-deferred, the account could be worth more than $1 million by the time she retires.

A trust or an estate must empty an IRA much faster because it has no life expectancy.

To avoid this problem, you need a correctly written “see-through” trust, which can take minimum annual IRA distributions based on the life expectancy of its own beneficiary. This trust takes minimum IRA distributions and passes them to your heir, who pays taxes on them. (You don’t want distributions accumulating in the trust, which is taxed at a higher rate.)

To qualify as “see-through,” the trust must be valid under state law, and irrevocable. Its beneficiaries must be eligible to be designated IRA beneficiaries. And 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.

THE BOTTOM LINE If you make a trust your IRA beneficiary, do it carefully.

WEBSITES WITH MORE INFORMATION bankrate.com and investopedia.com

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