Tax Tips When Naming a Trust as IRA Beneficiary

by Prof. Robert Bloink and Prof. William H. Byrnes

With all of the significant changes governing required minimum distributions (RMDs) from inherited retirement accounts post-SECURE Act, many clients may have a renewed interest in naming a trust or their estate as their retirement account beneficiaries.  After all, trusts are commonly used to simplify a distribution of assets according to a client’s wishes after their death.  In reality, life tends to become much more complicated when a trust or estate is named as a retirement account beneficiary—but that doesn’t mean the inherited IRA funds will automatically be subject to the higher tax rates that apply to trusts and estates.  Before naming a trust as a client’s IRA beneficiary, it’s critical to understand the detailed rules that will apply with respect to RMDs and tax liability to avoid unpleasant surprises down the road.

How Does a Trust or Estate Impact the Beneficiary Designation?

As an initial matter, it’s critical to remember that when a trust is listed as an IRA beneficiary, it really is the trust itself is the technical IRA beneficiary.  When a trust or estate is listed as the account beneficiary, the trust or estate itself must be named as the owner of the inherited account (not the trust’s beneficiaries).

In administering the inherited account, the trustee or the executor of the estate will be responsible.  The trustee (or executor) and the trust itself will be named on the title of the inherited IRA.

How Do RMDs Work When a Trust is Named Beneficiary?

The SECURE Act fundamentally changed the rules governing RMDs from inherited accounts.  As brief background, post-SECURE act, retirement account beneficiaries who do not qualify as eligible designated beneficiaries must now empty an inherited retirement account (and pay the associated taxes) within ten years of the original owner’s death.  Eligible designated beneficiaries include surviving spouses, the owner’s children who are not yet 21 years old, disabled or chronically ill individuals and individuals who are not more than 10 years younger than the account owner.

Trusts and estates are treated differently.  These legal entities are subject to the RMD rules that apply when a non-human inherits the account.  Aside from a lump sum distribution option, the trust or estate beneficiary has two options for emptying the account: a five-year distribution period or a life expectancy method.

The five-year distribution period applies if the original account owner died before their required beginning date.  The required beginning date is currently April 1 of the year following the year the original owner turned 73 (70.5 or 72 if the owner died before the post-SECURE Act 2.0 age-73 required beginning date became law).  Unlike with the 10-year distribution window, there are no RMDs during the five-year period.  The trust can elect to wait until year five to empty the account if they wish.

When the owner dies on or after their required beginning date, the life expectancy rule applies.  The trustee or executor can elect to take distributions over the original account owner’s remaining life expectancy (had they lived).  The initial life expectancy factor is based on the original owner’s age in their year of death (subtracting one for each subsequent year).

How Does a See-Through Trust Beneficiary Change the RMD Rules?

Different RMD rules apply if the trust-beneficiary qualifies as a see-through (or “look-through”) trust.  When a trust qualifies as a see-through trust, the trust itself is “looked through” and the assets pass directly to the trust’s beneficiaries.

The trust must satisfy certain criteria to qualify.  First, the trust must be valid under state law and the relevant documentation must be provided to the IRA custodian.  The trust must also be irrevocable or will, by its terms, become irrevocable upon the death of the owner.  Finally, the trust’s human beneficiaries must be identifiable within the trust instrument (whether by name or because a class of beneficiaries, such as children, was named).

If the trust qualifies, the RMD rules that apply to the inherited account will depend on the identity of the beneficiaries.  In other words, the ten-year rule or life expectancy rule may apply, depending on the facts.

How is a Trust Beneficiary Taxed?

The tax treatment of the actual IRA funds will depend on the type of trust that is used.  If the trust is an accumulation trust (meaning that the funds are distributed to the trust and remain within the trust), the distribution is taxed at the trust’s tax rate.  The 37% rate bracket will kick in once the trust has income of only $15,650 in 2025 ($15,200 in 2024).

If the trust is a conduit trust that passes the distribution directly through to the trust’s beneficiary, the human beneficiary is taxed at their own ordinary income tax rate.

Conclusion

The rules that govern trust IRA beneficiaries are extremely complicated—and have changed significantly since the SECURE Acts were passed into law.  Before naming a trust as a retirement account beneficiary, it’s critical to understand the rules that apply to avoid adverse tax consequences moving forward.