What Is the Disadvantage of Leaving an IRA to a Trust?

Individual Retirement Accounts (IRAs) serve as a common vehicle for retirement savings, allowing assets to grow with tax advantages. Account holders typically designate beneficiaries to receive these funds upon their passing, ensuring a smooth transfer of wealth. While trusts are frequently utilized in broader estate planning, naming a trust as an IRA beneficiary can introduce specific disadvantages.

Accelerated Distribution Requirements

The passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act in 2019 significantly altered the rules for inherited IRAs, particularly impacting non-spouse beneficiaries. Prior to this legislation, individual beneficiaries could often “stretch” distributions over their own life expectancy, allowing for extended tax-deferred growth. However, the SECURE Act largely eliminated this provision, instituting a 10-year rule for most non-spouse beneficiaries, requiring the entire inherited IRA balance to be distributed by the end of the tenth year following the original owner’s death.

When a trust is named as an IRA beneficiary, the distribution timeline can become even more compressed unless the trust meets specific Internal Revenue Service (IRS) requirements to qualify as a “look-through” or “see-through” trust. If a trust fails to meet these criteria, the IRA may be treated as if there is no designated beneficiary, forcing distributions to occur much faster.

To qualify as a “look-through” trust, the trust must be valid under state law, become irrevocable upon the IRA owner’s death, and have identifiable individual beneficiaries. The trust document must also be provided to the IRA custodian by October 31 of the year following the account holder’s death. Even with “look-through” status, the 10-year rule generally still applies to the trust’s individual beneficiaries, unless they meet the definition of an “eligible designated beneficiary” (EDB).

Eligible designated beneficiaries include surviving spouses, minor children of the original IRA owner, individuals who are disabled or chronically ill, and individuals not more than 10 years younger than the original IRA owner. It is rare for a trust itself to qualify for EDB treatment. The presence of just one non-EDB beneficiary within a trust can subject the entire trust to the 10-year rule, significantly accelerating tax obligations.

Taxation of Trust-Owned IRAs

Income retained within a trust is often subject to less favorable tax treatment than income distributed directly to individual beneficiaries. Trusts face highly compressed federal income tax brackets, meaning they reach the highest marginal tax rates at much lower income thresholds compared to individuals. For instance, in 2024, a trust’s taxable income exceeding $15,200 is subject to the top federal income tax rate of 37%, whereas a single individual does not reach this rate until their taxable income exceeds $609,350.

This disparity can lead to a substantially higher overall tax burden on IRA distributions if the trust accumulates income rather than distributing it promptly. If a trust distributes income to its beneficiaries, the trust typically receives an income distribution deduction. The distributed income is then taxed at the individual beneficiary’s personal income tax rate, which is generally lower than the trust’s rate for similar income levels.

However, if the trust is structured as an “accumulation trust” and retains the IRA distributions, those funds are taxed at the trust’s compressed rates. This approach can result in a significant portion of the inherited IRA assets being eroded by taxes. An individual beneficiary, by contrast, has the flexibility to manage their inherited IRA distributions over time, potentially spreading income across multiple tax years to remain in lower tax brackets.

Administrative Complexity and Costs

Establishing and maintaining a trust as an IRA beneficiary introduces notable practical and financial burdens. The initial setup involves legal fees for drafting a trust document sophisticated enough to manage IRA assets and comply with IRS requirements, such as “look-through” provisions. These legal costs can range from approximately $1,000 to $7,000, with more complex arrangements potentially incurring higher fees.

Beyond the initial drafting, ongoing administration of a trust that holds IRA assets requires diligent oversight. The trustee, whether an individual or a professional entity, is responsible for managing distributions according to the trust’s terms, maintaining meticulous records, and ensuring adherence to both the trust document and tax laws. This role demands a considerable investment of time and expertise.

Professional fees for managing a trust can be substantial. A professional trustee typically charges an annual fee ranging from 1% to 2.5% of the trust’s total assets. If a non-professional serves as trustee, their fees might be lower or an hourly rate. Annual accounting fees for preparing the trust’s federal income tax return (Form 1041) are also common, typically starting at $850 or more. These recurring costs can reduce the overall value of the inherited IRA assets available to beneficiaries over time.

Reduced Flexibility for Beneficiaries

Placing an IRA into a trust can significantly limit the control and direct access that individual beneficiaries would otherwise have over the inherited funds. When an IRA is left to a trust, the trustee, not the individual beneficiary, controls the IRA assets and dictates the timing and amount of distributions based on the trust document. This means beneficiaries cannot simply withdraw funds as they wish.

Beneficiaries are bound by the trust’s specific distribution rules, which may be restrictive. For example, the trust might stipulate that funds can only be distributed for certain purposes, such as education or healthcare expenses, or upon the beneficiary reaching specific ages or milestones. This structured approach can prevent beneficiaries from accessing funds when they might need them for other purposes.

Unlike an individual inherited IRA where the beneficiary can manage the investments, a trust dictates the investment strategy and administration of the inherited funds. This removes direct management authority from the ultimate recipients. The lack of direct control can also lead to disagreements between beneficiaries and trustees regarding investment decisions, distribution schedules, or the interpretation of the trust’s terms, potentially creating family discord.