Ask the Expert: Leave IRA to a trust — if you can afford it
Does it make sense to leave an individual retirement account (IRA) to a trust for a spendthrift heir?
Maybe, if you can afford the tax cost.
Historically, there were two reasons to leave an IRA to a trust: to prolong its tax deferral over your heir’s life expectancy and/or to control the account assets after your death.
The first reason is almost gone because most IRAs inherited after Jan. 1, 2020, must be emptied within 10 years of the original owner’s death. (Only five categories of beneficiary are exempt from the 10-year rule: surviving spouses; the deceased IRA owner’s minor children — not his or her grandchildren — until they reach maturity; disabled beneficiaries; chronically ill beneficiaries; and beneficiaries no more than 10 years younger than the deceased IRA owner.)
You may still want a trust to protect assets for an heir who can’t handle money. But the tax bill for keeping IRA assets in a trust can be prohibitively expensive, says Ed Slott, a Rockville Centre tax accountant. IRA assets that stay inside a trust instead of being paid out to the trust beneficiary are taxable at trust tax rates.
“For 2023, a trust will reach the top federal tax rate — 37% — after just $14,450 of income,” says Slott. “Individuals wouldn’t hit that 37% rate until their income exceeds $578,125. That’s a huge difference.”
One option is to pay the taxes on the IRA yourself by converting it to a Roth IRA, paying taxes on the conversion, and then leaving the Roth IRA to a trust. “The inherited Roth IRA must be emptied into the trust by the end of the 10th year after your death, but it will be income tax free,” Slott said.
The bottom line
Sheltering IRA assets in a trust can be prohibitively expensive.
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