Should You Put Certificates of Deposit in a Trust?

Placing Certificates of Deposit (CDs) into a trust is a financial strategy individuals consider for asset management and distribution. This approach involves specific considerations regarding deposit insurance and taxation. Understanding CDs and trusts provides a foundation for exploring how they interact within an estate plan. This article covers the practicalities, insurance implications, and tax treatment of trust-held CDs.

Basics of Certificates of Deposit

A Certificate of Deposit (CD) is a savings account that holds a fixed amount of money for a fixed period, such as six months, one year, or five years. The issuing financial institution pays interest at a predetermined rate. Unlike regular savings accounts, CD funds are locked in until maturity. Withdrawing money early usually incurs a penalty, affecting interest earned or principal.

CDs are low-risk investments because their returns are predictable and backed by federal deposit insurance. The interest rate remains constant, offering a stable return for conservative investors.

Basics of Trust Structures

A trust is a legal arrangement where a grantor transfers assets to a trustee. The trustee manages these assets for a beneficiary. This structure ensures assets are managed and distributed according to the grantor’s instructions, even if the grantor cannot manage them personally.

Key roles include the grantor (creates and funds), the trustee (manages assets), and the beneficiary (receives benefits). Trusts are either revocable or irrevocable. A revocable trust can be altered or dissolved by the grantor, offering flexibility. An irrevocable trust cannot be changed once established, providing benefits like creditor protection or specific tax advantages.

Assets placed into a trust are legally owned by the trust entity, separating them from the individual’s personal estate.

Holding Certificates of Deposit Within a Trust

Placing a CD into a trust requires re-titling the asset from individual to the trust’s legal name. The grantor or trustee contacts the issuing bank to initiate this change. The bank requires paperwork to retitle the CD, often needing the trust’s full legal name, such as “The [Trust Name] Trust, [Date], [Trustee Name] Trustee”.

The account’s tax identification number (often the grantor’s Social Security number for revocable trusts) may remain the same. Ensure the bank processes the change without triggering early withdrawal penalties. Some financial institutions may require waiting until the CD matures before re-titling.

Individuals consider placing CDs into a trust to avoid probate, the court-supervised process of distributing assets after death, which can be time-consuming and costly. A CD held in a trust bypasses probate and is distributed directly to beneficiaries according to the trust’s terms, ensuring a smoother, more private wealth transfer. Another reason is to provide for asset management if the grantor becomes incapacitated; a successor trustee can manage the CD and other trust assets without court intervention.

Once a CD is held within a trust, the trustee manages it according to the trust document. This includes renewing the CD, choosing new terms, or accessing funds as permitted. The trust document dictates how interest payments are received and managed; income might be distributed to beneficiaries or accumulated within the trust. The trustee ensures actions align with the grantor’s wishes and beneficiaries’ interests, adhering to fiduciary duties.

Deposit Insurance for Trust-Held Certificates of Deposit

The Federal Deposit Insurance Corporation (FDIC) insures deposits, including CDs, held in FDIC-insured banks. For trust-held CDs, FDIC rules apply to coverage calculation, potentially allowing greater protection than individual accounts. As of April 1, 2024, the FDIC simplified its rules, combining revocable and irrevocable trusts into a single ownership category for insurance.

Under the updated rules, a trust account is insured up to $250,000 per unique beneficiary, with a maximum coverage of $1,250,000 per trust owner, per insured bank, if five or more eligible beneficiaries are named. For example, a single grantor’s trust with five unique beneficiaries could have deposits insured up to $1,250,000 ($250,000 x 5 beneficiaries) at one bank. If a trust has multiple owners, such as a married couple, the insurance limit is multiplied by the number of owners. A joint trust with two owners and three beneficiaries could be insured up to $1,500,000 (2 owners x 3 beneficiaries x $250,000).

To qualify for this expanded FDIC coverage, beneficiaries must be identifiable, and their interests in the trust must not be contingent on events other than survival. The trust relationship must also be clearly indicated in the bank’s records. While a trust can name more than five beneficiaries, the maximum FDIC coverage for a single owner’s trust accounts at one bank remains capped at $1,250,000.

Taxation of Trust-Owned Certificates of Deposit

Interest income from CDs held within a trust is subject to taxation, depending on the trust type. For grantor trusts, including most revocable living trusts, the trust is disregarded for income tax purposes. Interest earned by the CD is reported directly on the grantor’s personal income tax return (Form 1040). The grantor pays taxes on this income, even if it remains within the trust and is not distributed.

Non-grantor trusts, such as irrevocable trusts, are considered separate tax entities. These trusts may file their own income tax return, IRS Form 1041, if they have taxable income or gross income of $600 or more. For non-grantor trusts, CD interest income can be taxed at the trust level or, if distributed, to the beneficiaries. Distributable Net Income (DNI) allocates this income. DNI is the maximum income passed from the trust to beneficiaries; if distributed, it is taxed to beneficiaries, preventing double taxation. Professional guidance is beneficial for understanding these tax obligations.