22 Jun How should payouts be made from an inherited IRA that’s in a trust?
Q. An IRA was held by a spousal living trust and the second spouse died. The beneficiary is the spousal trust which has automatically converted to a family trust to benefit the seven children who are all adults. Should the money remain in the IRA or should it be cashed in and distributed to the seven siblings?
A. It depends.
(We know, that’s not always a satisfying answer.)
Let’s first look at the inherited IRA rules for deaths occurring in 2020 and beyond.
The laws regarding when the assets in an IRA must be withdrawn following death significantly changed with the passage of the SECURE Act in 2020, said Samantha Rocco, an attorney with Einhorn, Barbarito, Frost & Botwinick in Denville.
If the original account owner died in 2019 or prior, different — and more beneficial — rules would apply, she said.
But we’re going to assume the original account owner of the IRA died after 2020, the IRA is a traditional IRA and not a Roth and that the primary beneficiary designated a successor beneficiary on the inherited IRA.
When a trust, rather than an individual, inherits an IRA, the withdrawal requirements are rather complicated, Rocco said.
“Assuming that the IRA had a beneficiary designation naming the trust as the beneficiary of the IRA, one must look to the terms of the trust to determine whether the trustee must distribute Required Minimum Distributions each year to the beneficiaries or may accumulate the distributions in the trust in the trustee’s discretion,” Rocco said.
For purposes of determining the amount of time one has to withdraw the IRA assets, trusts are categorized as either “conduit trusts” or “accumulation trusts.”
A conduit trust requires the trustee to pay out all distributions, including Required Minimum Distributions from an IRA, to the beneficiaries of the trust each year, she said. Generally, in the case of a conduit trust, where the beneficiary is an individual (i.e., non-entity), the inherited IRA assets must be withdrawn within 10 years of the original account owner’s date of death, subject to certain exceptions for “eligible designated beneficiaries,” she said.
An accumulation trust provides the trustee with discretion to accumulate the IRA distributions in the trust for later distribution for the beneficiary of the trust, Rocco said. Likewise, generally, in the case of an accumulation trust where the beneficiary is an individual beneficiary, the inherited IRA assets are subject to a 10-year withdrawal period, subject, again, to certain exceptions for “eligible designated beneficiaries.”
Now the question becomes “Well, is the trustee required to take certain minimum distributions from the inherited IRA or can the trustee allow the IRA assets to grow tax-free and withdraw all of the IRA assets right before the 10-year time period expires?”
“Until recently, where the 10-year rule applied, many tax professionals understood that beneficiaries were permitted to withdraw the IRA assets bit-by-bit over the course of the 10 years or alternatively, allow the IRA assets to grow tax-free for 10 years and withdraw all of the IRA assets at the very end of the 10-year time period,” Rocco said. “However, the IRS has recently promulgated proposed Treasury Regulations regarding Required Minimum Distributions on IRAs, which set forth a new policy.”
Needless to say, if you are not currently working with a tax professional, it may be a good time to start.
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This story was originally published on June 22, 2022.
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