IRA Inheritor’s Trusts: Pros and Cons

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 What Is a Trust?

A trust is a device that is used in estate planning. The person who forms the trust is known as the trustor or settlor. A trust directs an individual, a trustee, to hold the trustor’s property subject to specific duties.

These responsibilities include using and protecting the trust assets for other individuals, known as beneficiaries.

What Is an Individual Retirement Account (IRA)? What Is an IRA Inheritor’s Trust?

An Individual Retirement Account, or “IRA,” is a common type of private retirement plan. An IRA can be either employer-provided or self-provided, giving certain tax benefits to the policyholder.

Monetary contributions are made to the account, with the IRA owner investing this money into most types of securities. The money is held by a custodian, such as a bank or a brokerage firm. The custodian is accountable for the actual investing at the direction of the IRA owner. Transactions made within the account are not taxed, such as interest and capital gains.

It is common for an IRA owner to fail to use all of their funds, and leave the remainder of the account to heirs. The account is subject to specific conditions, such as a minimum required distribution. Additionally, the new beneficiary may not comprehend the advantages of withdrawing only the minimum amount and letting the investments amass so that the money lasts. Many IRA owners create a trust in their wills to remedy this, so their IRA accounts are left to the trust, with their heirs as beneficiaries. This type of trust is known as an IRA Inheritor’s Trust.

The primary objective of an IRA Inheritor’s Trust is to stop overspending or using up all of the retirement funds too prematurely. It is most efficacious when the funds are spread out over time. The trustee is answerable for ensuring that the money in the account is distributed correctly through minimum distributions. This ensures that the money lasts as long as possible and that the beneficiaries are getting the most out of the account. Another benefit to an IRA Inheritor’s Trust is that the trust protects from creditors or loss in a divorce.

What Is a Trustee?

A trustee is an individual who holds legal title to the property included in a trust. The trustee does not own the property. They have a fiduciary duty to fulfill duties to the beneficiaries imposed by the trust.
Fiduciary duties are responsibilities to act in the interest of another person. The trustee is bound to observe the rules outlined in the trust and work only to benefit the trust’s beneficiaries.

Examples of a trustee’s fiduciary duties may include:

  • A duty of loyalty requires the trustee to ensure that the beneficiaries’ interest in the trust property is protected. The trustee may not take any actions in their favor that would impair the interests of the beneficiaries;
  • A duty of care requires the trustee to make decisions with care and diligence. According to the duty of care, a trustee is responsible for making reasonable decisions regarding when, how, and what to invest; and
  • A duty of accounting requires the trustee to make an account of and keep records of all financial transactions that concern the trust property. The trustee must keep detailed records of all expenses required to administer the trust, including broker fees.

What Are the Tax Implications of an IRA Inheritor’s Trust?

The person who inherits the IRA will encounter the same tax implications that the original owner faced. This means that the funds acquired from the account will be taxed as income.

One significant advantage of the trust is that the trustee assures that the account is not subject to IRS penalties for failure to make the mandated minimum distributions. It is essential to have an experienced tax lawyer set up the trust. It is also crucial for the trustee to be familiar with tax laws to avoid possible tax penalties.

What Are Some Conflicts that Are Associated with IRA Inheritor’s Trusts?

Some disputes may be associated with IRA Inheritor’s Trusts. These trusts are primarily dependent upon the skills and knowledge of the account’s trustee. Because of this, one of the most common disputes associated with this type of trust occurs when a trustee fails to manage the trust efficiently and lawfully.

For instance, a conflict may occur if the trustee disregards the legal requirements for minimum distributions. This failure could hurt the trust’s beneficiaries.

What Are Some of the Pros and Cons Associated With an IRA Inheritor’s Trust?

IRAs, in general, have some advantages, such as being able to make contributions without being taxed annually for your capital gains.

Traditional IRA benefits include:

  • Tax-deductible contributions;
  • Earnings and gains are not taxed, which lets those investments grow;
  • Anyone accumulating an income can contribute to an IRA account; and
  • The IRA contributions can be used on investment options, such as mutual funds, stocks, bonds, and CDs.

As previously mentioned, the most significant advantage to an IRA Inheritor’s Trust is that the money is less likely to be spent recklessly or too quickly. It ensures that the funds are stretched out over time to maximize the efficiency of distribution. Additionally, an IRA Inheritor’s Trust can bypass specific IRS penalties, such as those associated with failing to make minimally required fund distributions to beneficiaries.

Nevertheless, there are some detriments regarding an IRA Inheritor’s Trust. The trustee will need to confirm that the requirements for minimum distribution are being met; failure to do so could result in tax penalties. Beneficiaries relinquish some amount of control over the IRA funds in exchange for the guidance and direction of the trustee.

The person who inherits the IRA will face the same tax implications that the original owner did; the money received from the account will not be taxed as income. The account’s trustee will ensure that the account does not become subject to IRS penalties due to failing to make the required minimum distributions.

What Are Some Issues That Are Associated With IRA Inheritor’s Trusts?

IRA Inheritor’s Trusts are primarily conditional upon the skill and knowledge of the account’s trustee. As such, one of the most common disputes associated with IRA Inheritor’s Trusts occurs when the trustee fails to manage the trust in a manner that is efficient and lawful. An example of this will be if the trustee disregards the legal requirements for minimum distributions. Such a failure could negatively affect the trust’s beneficiaries.

A dispute may also arise when one or more beneficiaries attempt to claim the funds in opposition to the trust instructions. A similar disagreement would be a will contest in which a family member may take issue with the way property is being disseminated in a will. In such circumstances, the conflict could lead to a lawsuit that involves contentions between beneficiaries or the trustee.

Do I Need an Attorney for IRA Inheritor’s Trusts?

You should consult with a skilled and knowledgeable trust lawyer if you would like to set up an IRA Inheritor’s Trust or are facing problems related to an IRA Inheritor’s Trust. The trust must be set up by an experienced lawyer, whether a tax lawyer or an estate lawyer, to avoid any possible tax penalties and other disputes. An experienced lawyer can also represent you in court, should any disputes result in a lawsuit.


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