Q. I have a traditional IRA. The plan allows me to designate individuals, trusts or my estate as individual, but it does not recognize wills. I am older than the RMD start date. With my will, I want to establish trusts for certain beneficiaries, with payouts beginning at least 10 years from now, to avoid spendthrifts. How would it work in terms of taxes and the timing of the payouts?
A. The SECURE Act, which was effective Jan. 1, 2020, made big changes to what happens with inherited IRAs.
Before it passed, beneficiaries could spread out distributions from an inherited IRA account over their life expectancy. But that’s no more.
“With the passage of the SECURE Act, unless the beneficiary is your spouse, the rules with respect to distribution of inherited IRAs have substantially changed,” Romania said.
“Under the prior rules, minimum annual distributions were required to be taken by the beneficiary, whereas under the new rules the entire payout can be taken in year 10 without any penalty,” she said. “This allows for, and requires, income tax planning by the beneficiary who will be taxed on the distributions from the retirement account unless the distributions are from a Roth IRA.”
A beneficiary of a retirement account can also be an individual beneficiary of a “conduit trust” or an “accumulation trust,” she said.
“A conduit trust distributes to the primary beneficiary all amounts distributed from the IRA and received by the trustee thus for most beneficiaries, that means by the end of the tenth year after the owner’s death,” Romania said. “Since the income from the IRA is distributed to the trust beneficiary, it is taxed at the beneficiary’s individual income tax rate.”
An accumulation trust allows distributions from the retirement account to be accumulated in the trust for the benefit of the beneficiary, Romania said.
“Income accumulated in the trust will be taxed in the trust at the trust’s tax rate. However, if the trust distributes any income to the beneficiary in the year a distribution is made from the IRA, the income can be `passed through’ to the beneficiary, allowing the income to be taxed at the beneficiary’s tax rate.”
Overall, accumulation trusts provide greater creditor and spendthrift protection, she said.
A beneficiary designation naming an estate or a trust that does not meet the requirements of a conduit or accumulation trust will result in a required payout within five years instead of 10 years, she said.
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Karin Price Mueller writes the Bamboozled column for NJ Advance Media and is the founder of NJMoneyHelp.com. Follow NJMoneyHelp on Twitter @NJMoneyHelp. Find NJMoneyHelp on Facebook. Sign up for NJMoneyHelp.com’s weekly e-newsletter.