How can an IRA inheritance trust protect your beneficiaries after the SECURE Act?

Key Takeaways:

An IRA inheritance trust is a trust drafted specifically to be named as beneficiary of an IRA or other retirement account and to manage inherited retirement distributions after the account owner’s death. After the SECURE Act, most non-spouse designated beneficiaries must empty an inherited IRA within 10 years, compressing tax-deferred growth and possibly pushing heirs into higher tax brackets. A properly drafted IRA trust can help preserve the most favorable payout period available under current law, control how funds are spent, and provide a layer of protection from beneficiary-level risks without unnecessarily accelerating income taxes.

Retirement accounts are often the largest single asset in a Pennsylvania estate. They are also among the easiest assets to mishandle in inheritance. A spouse who inherits an IRA has flexible rollover options. A child or grandchild who inherits an IRA, however, is governed by a stricter set of rules. Poor planning can accelerate income taxes or cause the account to be depleted faster than the original owner intended.

An IRA inheritance trust is a planning tool designed specifically for that situation. The Bucks County estate planning attorneys at Ruggiero Law Offices regularly help families structure these trusts so retirement assets pass efficiently to the next generation.

How an IRA Inheritance Trust Works

An IRA inheritance trust, sometimes called an IRA stretch trust or retirement plan trust, is a trust drafted to be named as the beneficiary of one or more IRAs. 

When the account owner dies, the IRA custodian administers the account as an inherited IRA for the benefit of the trust. The trustee receives required distributions from the IRA, and then either holds those funds in trust for the beneficiary or distributes them in accordance with the trust's terms.

IRS Requirements

To preserve favorable tax treatment, the trust must qualify as a see-through trust under IRS regulations. That generally requires that the trust be valid under state law, become irrevocable no later than the account owner’s death, and be identifiable as to its beneficiaries, with the trustee providing the documentation required by the IRA custodian. 

A trust that fails these requirements may be treated as having no designated beneficiary, which can accelerate distributions under the five-year rule if the owner died before the required beginning date or under the owner’s remaining life expectancy if the owner died after that date.

How the SECURE Act Changed the Rules

Before the SECURE Act of 2019, most non-spouse beneficiaries could stretch distributions from an inherited IRA over their own life expectancy, sometimes 40 years or more. The SECURE Act eliminated that option for most non-spouse designated beneficiaries who are not eligible designated beneficiaries and replaced it with a 10-year rule: 

The inherited IRA must generally be fully distributed by December 31 of the year containing the 10th anniversary of the original owner’s death.

There are still categories of beneficiaries — known as eligible designated beneficiaries — who can stretch distributions over a longer period. They include:

• Surviving spouses.
• Minor children of the account owner, but only until they reach the applicable age of majority.
• Disabled or chronically ill individuals.
• Individuals not more than 10 years younger than the account owner.

For a minor child of the account owner, life-expectancy treatment is temporary; the remaining account balance must generally be distributed within 10 years after the child reaches the applicable age of majority.

Most other beneficiaries — including adult children and grandchildren — are subject to the 10-year rule. Updated IRS regulations also require many beneficiaries subject to the 10-year rule to take annual minimum distributions during years 1 through 9 if the original owner died on or after the required beginning date; if the owner died before that date, the beneficiary may not need annual distributions before year 10.

An IRA inheritance trust is one way to manage those distributions while still controlling how funds are spent, but it does not extend the 10-year deadline for most adult children or grandchildren.

Tax Planning Benefits of an IRA Inheritance Trust

Used correctly, an IRA inheritance trust can offer several tax planning benefits for Pennsylvania families:

• Continued tax deferral. Funds that remain inside the inherited IRA can continue to grow tax-deferred during the applicable payout period, subject to the 10-year rule and any annual RMD requirements.
• Bracket management. The trustee can coordinate the timing of IRA withdrawals and beneficiary distributions within the applicable payout rules, but accumulated trust income may be taxed at compressed trust income tax rates.
• Trust-level planning. For some families, accumulating distributions inside the trust may be preferable for asset-protection or beneficiary-management reasons, even though the income tax cost should be modeled carefully.
• Coordination with other strategies. The trust dovetails with other tax-smart estate planning strategies already in place, including charitable giving and lifetime gifting.

Asset Protection and Control Over Beneficiaries

Tax planning is only one reason families use an IRA inheritance trust. The structure can also help protect beneficiaries from outside risks.

An inherited IRA paid directly to a child becomes that child’s property and may be exposed to future divorce, lawsuits, bankruptcy, or creditor claims, depending on applicable law. Funds held in a properly drafted trust, by contrast, may receive a layer of protection through spendthrift provisions and can be managed under terms the original owner chose.

Common drafting choices include:

• Conduit trust language, which generally requires the trustee to pass IRA distributions out to the beneficiary as they are received and may reduce long-term asset protection.
• Accumulation trust language, which permits the trustee to retain distributions inside the trust for asset protection or beneficiary-management reasons, while requiring careful income-tax planning.
• Special needs provisions, so that an inheritance does not disqualify a disabled beneficiary from public benefits.
• Staggered distribution schedules, similar in spirit to the protections often built into a trust for a child or grandchild.

Mistakes to Avoid With Retirement Account Inheritance

Even strong estate plans get derailed when an IRA beneficiary designation is not coordinated with the trust. We frequently see:

• An IRA still naming a long-deceased spouse, an ex-spouse, or no beneficiary at all.
• Naming a revocable trust as an IRA beneficiary without provisions and beneficiary designations designed to satisfy the see-through trust requirements.
• Beneficiary designations that conflict with the will, leaving the family in dispute.
• No coordination between the IRA trust and the rest of the plan, including pour-over wills, life insurance, and probate-avoidance strategies.

Each of those problems is fixable while the account owner is living. After death, options narrow quickly. A periodic review of trust documents and IRA custodian beneficiary forms with a Bucks County estate planning attorney, at least every few years and after any major life event, helps keep an IRA inheritance trust working the way it was designed to work.