Beneficiary Planning: Strategies When Naming a Trust | Lord Abbett

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Retirement Perspectives

While naming a trust as a beneficiary of a retirement account offers numerous benefits, those advantages may come with additional costs and tax implications.

Second of a two-part series

If you choose to name a trust as the beneficiary of a retirement account (IRA, 401(k), etc.) rather than an individual (spouse, child, grandchild, etc.), there are a number of considerations that must be evaluated beforehand. Last week, we covered the strict, complicated, and cumbersome IRS rules that need to be followed. Here, we’ll explain the steps account owners need to take when naming a trust as the beneficiary, plus insights about taxation and why bequeathing a Roth IRA appeals to many investors.

How Do Trusts Work?
When a trust is named as the beneficiary of a retirement account, these are the steps to follow:

  1. Account should be retitled as an inherited IRA, 401(k), etc. The account is not paid out to the trust.
  2. Required minimum distributions (RMDs) are made from the retirement account to the trust. In other words, the RMD is a distribution from the IRA paid to the trust. Only the RMD amount must be moved, each year, from the IRA to the trust. 
  3. Distributions are then made to beneficiaries following trust language. The trustee, assuming that the trust language permits, can make additional distributions, for example, upon attaining a minimum age, time, and or life event (from the trust) to the beneficiaries of the trust.

Retitling an Inherited IRA
A trust beneficiary should be retitled as follows:

John Smith, IRA (died February 1, 2019)
For the benefit of (FBO) James Smith, Trustee of the Smith Trust, beneficiary

It’s imperative that the account is registered using the trust federal identification number—not the Social Security of the deceased. Retitling an account incorrectly has severe consequences. Instead of having an inherited account, you will instead have a distribution to the trust, subject to immediate taxation.

Trust Beneficiary and Taxes
Nearly every trust has its own unique set of rules, and each family has its own unique dynamic. So, when assessing a trust, consider a team approach to designing and implementing it. Involve all centers of influence, such as a tax professional, an experienced attorney, and trustee. Notably, an account owner can make his or her trust liberal, or conversely, if he/she wants more post-death control, more rigid. It’s up to the account owner—with one caveat: the inherited IRA must pay out at least the required minimum amount (to the trust) annually.

Using a trust to inherit an IRA poses several tax risks if not designed properly. First, the trust could wind up paying higher taxes than individuals would. For example, in 2019, the top trust tax rate of 37% applies to income exceeding $12,750 versus income exceeding $612,350 for married individuals filing jointly ($510,300 for single taxpayers). However, heirs can avoid paying the higher trust tax rate, assuming the trustee can pass all distributions to the trust beneficiary, as opposed to retaining income inside the trust.

The 3.8% net investment income (NII) surtax also needs to be addressed. This surtax affects trusts and estates as well as individuals. The surtax applies to taxpayers whose modified adjusted gross income (MAGI) exceeds $200,000 (single) or $250,000 (married filing jointly); neither figure is indexed for inflation. In 2019, trust income in excess of $12,750 is taxed at the highest individual tax rate of 37%, plus 3.8% NII plus state taxes if applicable.

With some advanced planning, a trust can offer the trustee both the needed flexibility and discretion to decide how much income to distribute to beneficiaries based on their needs, along with how much income will remain after taxes. Periodically review language ensuring the trust continues to meet an account owner’s objectives. A review is especially important now that tax reform has been implemented.


2019 Federal Income Tax Brackets
Individuals, married filing jointly, trusts and estates

Source: Manning & Napier.


Conduit Trust versus Accumulation Trust
A properly drafted trust will not only qualify for “look-through” treatment, but also will address whether to be arranged as a conduit or accumulation trust.

A conduit trust serves as a conduit to pass minimum distributions from the inherited IRA to trust beneficiaries. Take the following steps to ensure the distributions are done properly: RMDs should be paid from the inherited IRA to the trust, then from the trust to IRA beneficiaries. Consequently, no minimum distributions (from the inherited IRA) would remain in the trust, which in turn eliminates any trust taxes. Instead, trust beneficiaries would pay tax on distributions (received as K-1 income) at their own individual income tax rates.

An accumulation trust (sometimes referred to as a discretionary trust) is generally used by individuals who want full and total control of post-death distributions. Why? An accumulation (as opposed to a conduit) trust does not have to pay out all IRA distributions to trust beneficiaries. Instead, the trustee has discretion to either pay out nothing, a portion, or all of the IRA distributions to trust beneficiaries. But any IRA distribution amounts not paid (to trust beneficiaries) are considered accumulated (in the trust) and taxed at trust tax rates. The trustee can choose to retain annual RMDs in the trust (although RMDs must still be paid from the IRA to the trust), but the trustee is not required to make payment to trust beneficiaries.

As noted, a qualifying trust is required to use the life expectancy of the oldest beneficiary (e.g. beneficiary with the shortest life expectancy)  to determine annual post-death RMDs. For accumulation trusts, the post-death payout rules require using the ages of both primary and remainder beneficiaries to determine who is the oldest beneficiary. However, for conduit trusts, only the primary beneficiary’s age is used to determine post-death RMDs.

Separate accounts (also known as “splitting”) are not permitted when a trust is named as an IRA beneficiary. Why? The trust is itself deemed the beneficiary, not the underlying trust beneficiaries.

Consider Leaving a Roth to a Trust
Inheriting a Roth IRA through a qualifying trust follows the same post-death RMD rules as a traditional IRA—with one significant difference: in the case of a Roth IRA, RMDs generally will be income-tax free—as long as the five-year holding period has been satisfied. Therefore, an accumulation trust that holds a Roth IRA would eliminate the aforementioned trust tax issues for those situations when the trustee decides to retain income in the trust. Roth IRAs also are appealing to those beneficiaries who inherit via a conduit trust. The income paid out via annual distributions also would be free of income taxes. Roth IRA distributions are not taxable, whether they are left to a trust or a person.

Tip: Recent tax reform changed how the “kiddie tax” is determined. Beginning last year (2018), the “kiddie tax” is assessed based on the tax rates paid by trusts. Previously, this tax was determined based on the tax rate of the child’s parents. “Kiddie tax” is  generally assessed on the unearned income of a dependent child under age 18.

IRA distributions are considered unearned income. Therefore, when a child inherits a traditional IRA, taxable distributions could be assessed at compressed trust tax rates. If a child is expected to inherit a traditional IRA, the account owner (prior to death) can convert the traditional IRA to a Roth IRA. Why? A Roth IRA will pay tax-free distributions and bypass the kiddie tax.


To comply with Treasury Department regulations, we inform you that, unless otherwise expressly indicated, any tax information contained herein is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law, or (ii) promoting, marketing, or recommending to another party any transaction, arrangement, or other matter.

The information is being provided for general educational purposes only and is not intended to provide legal or tax advice. You should consult your own legal or tax advisor for guidance on regulatory compliance matters. Any examples provided are for informational purposes only and are not intended to be reflective of actual results and are not indicative of any particular client situation.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett's products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.


Trusts are often written to provide flexible provisions of how trust assets may be distributed.

Traditional IRA contributions plus earnings, interest, dividends, and capital gains may compound tax-deferred until you withdraw them as retirement income. Amounts withdrawn from traditional IRA plans are generally included as taxable income in the year received and may be subject to 10% federal tax penalties if withdrawn prior to age 59½, unless an exception applies.

A Roth IRA is a tax-deferred and potentially tax-free savings plan available to all working individuals and their spouses who meet the IRS income requirements. Distributions, including accumulated earnings, may be made tax-free if the account has been held at least five years and the individual is at least 59½, or if any of the IRS exceptions apply. Contributions to a Roth IRA are not tax deductible, but withdrawals during retirement are generally tax-free.

401(k) is a qualified plan established by employers to which eligible employees may make salary deferral (salary reduction) contributions on an aftertax and/or pretax basis. Employers offering a 401(k) plan may make matching or nonelective contributions to the plan on behalf of eligible employees and may also add a profit-sharing feature to the plan. Earnings accrue on a tax-deferred basis.

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