Living Trust Beneficiary of IRA Distributions
Choosing the right beneficiary designation for an Individual Retirement Account involves more than just knowing who is intended to get the assets upon your death. Proper designation can save the beneficiary thousands in income tax dollars, allowing him to preserve the tax-deferred structure of the IRA. A trust is treated very differently than a natural person.
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Natural vs. Non-natural Person
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A natural person is a living person whereas a non-natural person is an entity that has a tax identification number and exists in perpetuity but is not in itself a living person. A child, friend or neighbor is a natural person. A trust, charity or corporation is a non-natural person. Naming a natural person provides many more opportunities for liquidation compared to naming a non-natural person such as a family trust.
Options Provided Beneficiaries
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All beneficiaries can take a lump sum distribution when inheriting an IRA. The lump sum distribution liquidates all assets immediately and adds the distribution to the tax identification number of the beneficiary, whether it be a Social Security number or an Employer Identification Number as is the case with a family trust. The lump sum distribution is the only option available to non-natural beneficiaries. Living beneficiaries have a few other options including taking distributions over a five-year period or rolling the IRA into a beneficiary IRA to continue it throughout his lifetime. A surviving spouse has one more option which is to continue the IRA as her own. While the latter options reduce the income taxes owed shortly after the IRA owner's death, all IRA assets are included in the taxable estate for transfer tax purposes.
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IRA Trust Options
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There is a type of trust that an IRA can name as a beneficiary that is exempt from the lump sum distribution requirement. This is called an IRA Trust that has the sole purpose of preserving the assets in the IRA for the heir. The IRA Trust is a conduit trust with the IRA asset its only responsibility. The IRA names the trust, the trust has no assets and names one heir with the instructions of rolling the IRA into a beneficiary IRA. The trust states how much and how the beneficiary can take distributions. This trust is used when an IRA owner is concerned about a spendthrift beneficiary who might not use the funds wisely. Distributions are taken from the IRA, go immediately into the trust and are immediately dispersed.
The Family Trust
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When the family living trust is named as the beneficiary, the trust takes the lump sum distribution. Once the estate is cleared of all debts and obligations, the trust distributes the assets according to the designations listed in the trust. The trust might distribute the assets or retain them for asset preservation. If the IRA owner intends to preserve assets, naming the family trust is not the best option; the IRA trust or natural beneficiaries are.
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