The Tax Consequences of Putting IRAs in a Trust

Individual retirement accounts offer substantial income tax benefits when you use them to save for retirement. But, as the “individual” part of IRA suggests, you have to keep them in your name. Trying to circumvent this rule by titling an IRA in your trust during your lifetime will result in taxes and potential penalties.

If you’re doing estate planning, you can name your trust as the beneficiary of your account, but you’ll want to make sure it’s a qualifying trust to minimize the tax implications for your future beneficiaries.

IRAs must remain titled in your individual name during your lifetime. You’re not allowed to be a co-owner of an IRA with anyone else, including your spouse, nor are you allowed to retitle it in the name of your trust.

You could take all the money out of your IRA and transfer it to an account titled in the name of your trust, but then you’d incur income taxes on the distributions plus potential early withdrawal penalties. In addition, you’d also lose the ability for that money to continue to grow tax-free in the IRA until you needed distributions in retirement.

You can, however, name a trust as the beneficiary of your IRA upon your death. This can help you accomplish various estate planning goals, such as ensuring your spouse is taken care of but locking in where the assets will pass upon your spouse’s death, or holding the funds in trust for the benefit of young beneficiaries who aren’t quite ready to handle inheriting the money outright at their current age.

Typically, when a person inherits an IRA, that beneficiary can use his or her life expectancy to determine the minimum amount of money that must be withdrawn from the account each year. The longer the money can remain in the IRA, the longer the money can continue to grow tax-free and the longer you can delay paying taxes on the distributions.

However, if a trust is named as the beneficiary and the trust doesn’t include certain look-through trust provisions, the trust must empty the IRA within five years. This can accelerate how quickly the IRA must be emptied and potentially bump the trust or the beneficiaries into a higher income tax bracket.

In addition to faster-required distributions, trusts also have more compressed income tax brackets than individuals. For example, in 2019, trust income over $12,500 is taxed at the top tax rate of 37 percent. Married couples only pay that same 37-percent tax rate on income exceeding $612,350 and singles only pay that rate on income exceeding $510,300.