What Is a Conduit Trust and How Does It Work?

A conduit trust is a legal tool used in estate planning to manage inherited retirement funds like Individual Retirement Accounts (IRAs) or 401(k)s. Its function is to provide a structured way to pass these assets to a beneficiary after the account owner’s death. This structure allows the trust’s creator, known as the grantor, to control how the assets are distributed, which can be useful when a beneficiary is young or may not have experience managing significant financial assets.

By naming the trust as the beneficiary of a retirement account, the grantor can dictate the terms of how and when the heir receives the money. This arrangement is distinct from leaving funds directly to an individual, which would give that person immediate and unrestricted access. The trust acts as an intermediary, ensuring the grantor’s wishes for the long-term management of their retirement savings are followed.

Qualifying as a See-Through Trust

Before a conduit trust can function as intended for an inherited retirement account, it must meet a set of IRS requirements to be classified as a “see-through” trust. This classification is a prerequisite for the trust’s beneficiaries to be treated as if they were directly named as beneficiaries of the retirement account, which is necessary for certain tax treatments. Without meeting these standards, the trust may be subject to less favorable distribution rules and accelerated tax liabilities.

The requirements are:

• The trust must be legally valid under the laws of the relevant state.
• The trust must become irrevocable upon the death of the retirement account owner, meaning its terms cannot be changed.
• The beneficiaries of the trust must be identifiable individuals, so the retirement account custodian can determine who the ultimate recipients are.
• For employer-sponsored plans like 401(k)s, a copy of the trust document or a certified list of all beneficiaries must be provided to the plan administrator by October 31 of the year following the account owner’s death.

Meeting these conditions allows the IRS to “see through” the trust and look to its beneficiaries for determining the payout schedule of the inherited funds. If a trust fails to meet these criteria, it may be considered a non-qualified beneficiary, leading to a much faster and often less tax-efficient payout of the retirement account assets.

Conduit Trust Distribution Rules

The defining feature of a conduit trust is its mandatory “pass-through” requirement for retirement account distributions. When the inherited retirement account must make a distribution, such as a Required Minimum Distribution (RMD), the trust receives that money and must immediately pay it out to the trust’s beneficiary. The trustee has no discretion to hold these specific distributions within the trust; it acts as a simple pipeline for these funds.

The rules governing these distributions were significantly altered by the SECURE Act, and the payout schedule now depends on whether the beneficiary is an “Eligible Designated Beneficiary” (EDB). EDBs are a specific group that includes the surviving spouse, minor children of the owner, disabled or chronically ill individuals, and beneficiaries not more than 10 years younger than the deceased account owner. If the beneficiary is an EDB, RMDs can be “stretched” over that beneficiary’s life expectancy.

For a minor child who is an EDB, this stretch treatment lasts only until they reach age 21. At that point, any remaining funds in the inherited retirement account must be fully distributed within 10 years. This provision ensures the tax-deferral benefits available to a minor child do not extend indefinitely into their adulthood.

If the beneficiary is not an EDB, such as an adult child or grandchild, the 10-year rule applies from the start. This rule requires the entire balance of the inherited retirement account to be withdrawn by the end of the 10th year following the year of the original owner’s death. For these beneficiaries, a conduit trust might not pay out anything for years one through nine, followed by a complete distribution of the remaining balance in year ten, as there are often no annual RMDs required during the 10-year window.

These rules apply only to distributions from the retirement account. The principal amount remaining inside the tax-deferred account is still managed by the trustee according to the trust’s terms. The trustee continues to protect and invest those assets until they are distributed.

Tax Treatment of Distributions

The tax implications of a conduit trust are tied to its pass-through nature. Because all Required Minimum Distributions (RMDs) from the inherited retirement account are immediately distributed to the beneficiary, the income tax liability also passes to them. The beneficiary reports the distribution as income on their personal tax return and pays taxes based on their individual income tax rate.

This approach contrasts with how undistributed trust income is taxed. If a trust retains income, that income is taxed at compressed trust tax rates, which escalate much more quickly than individual rates. For example, in 2024, a trust could hit the highest federal income tax rate of 37% on income over approximately $15,200, a bracket an individual taxpayer would need significantly more income to reach.

To illustrate, imagine an RMD of $20,000 is paid from an IRA to a conduit trust. That $20,000 is passed to the beneficiary, who might be in a 22% or 24% federal tax bracket, resulting in a tax of $4,400 or $4,800. If the trust were an accumulation trust that retained the funds, a significant portion of that $20,000 would be taxed at the highest 37% rate, leading to a much larger tax bill paid by the trust.

The tax efficiency of the conduit trust ensures that distributions are not subjected to the higher tax rates designed for retained trust income. By shifting the tax burden to the beneficiary, the overall tax paid on the distribution is often lower.

Establishing a Conduit Trust

Key Decisions and Information

Before creating a conduit trust, several foundational decisions must be made. The first step is to select a trustee, who will be the individual or institution responsible for managing the trust after your death. The trustee will handle investments, ensure compliance with legal requirements, and manage the flow of distributions from the retirement account to your beneficiary. The trustee should be reliable and capable of acting impartially in the beneficiary’s best interest.

You must also clearly identify the trust’s beneficiaries. You will name a primary beneficiary to receive the mandatory distributions from the inherited retirement account. It is also wise to name contingent, or secondary, beneficiaries who would inherit the assets if the primary beneficiary were to pass away before the retirement account is fully distributed.

The Creation and Funding Process

Once you have determined the trustee and beneficiaries, the next phase involves formal legal action. You will work with an estate planning attorney to draft the trust document. The attorney will ensure the document contains the specific conduit provisions required by the IRS, mandating that all distributions from the inherited retirement account are immediately passed through to the beneficiary.

After the trust document is drafted and signed, a final action is required to link it to your retirement assets. You must update the beneficiary designation form for your IRA, 401(k), or other retirement plan. On this form, you will name the newly created conduit trust as the primary beneficiary. This step is essential; if the trust is not formally named on the beneficiary form, the retirement account custodian will not recognize it, and your planning will be ineffective.