The Tax Consequences of Putting IRAs in a Trust

Putting assets into a trust can protect them from creditors after you die and can reduce estate taxes. However, putting an IRA into a trust is a really bad idea because the tax consequences are decidedly unfavorable. Fortunately, you can accomplish the same goals without ending up with a whopper of a tax bill.

IRAs and Trusts

The money in your IRA isn’t taxed while it stays in the account. Under Internal Revenue Service rules, only an individual can own an IRA. Even a married couple cannot jointly own an IRA, although each spouse may have a separate IRA. Trusts, on the other hand, exist to own things on behalf of a beneficiary. Assets in a trust are taxable. The person who sets up a trust, called the grantor, transfers ownership of assets to the trust. When the grantor dies, a trustee administers the assets on behalf of the beneficiaries according to the instructions given by the grantor.

Asset Ownership

The problem with putting an IRA into a trust is that it conflicts with IRS rules regarding ownership of the IRA. If you transfer ownership of the assets in an IRA to a trust, the IRS considers this act a taxable distribution. That means all of the money in the IRA is immediately taxable as ordinary income. If you are not yet 59 1/2 years old, this is an early distribution and you have to pay an additional 10 percent in penalty tax. To make matters worse, your IRA funds are no longer in an IRA as far as the IRS is concerned, so the tax-deferred status of any future earnings is lost.

Trusts as Beneficiaries

You can name a trust as the beneficiary of your IRA. Since naming a trust as beneficiary does not affect your ownership of the IRA while you are alive, there are no tax consequences. This can work well as a way of managing the distribution of your IRA assets to your children or other heirs. However, the trust has to make required distributions from the IRA, and these are taxable. If you want to leave your IRA assets to your spouse, you may want to make him the beneficiary instead of a trust. A spouse can roll over an IRA into his own IRA and so maintain the tax-deferred status of the funds.

Required Minimum Distributions

Under IRS rules, the beneficiary of any inherited IRA, including Roth IRAs, must make minimum required distributions each year on a schedule based on the beneficiary’s expected lifetime. The distributions are taxed as ordinary income in the year they are made. Making a trust the beneficiary of an IRA doesn’t alter the required minimum distribution rule. To comply with the rule, the trust must be set up as a conduit trust. Essentially, this means the trustee makes required minimum distributions and passes the money on to the beneficiaries.

About the Author

Based in Atlanta, Georgia, W D Adkins has been writing professionally since 2008. He writes about business, personal finance and careers. Adkins holds master's degrees in history and sociology from Georgia State University. He became a member of the Society of Professional Journalists in 2009.