Many readers ask me if there are any advantages in naming a trust as an IRA beneficiary. Although the IRS made slight improvements in the SECURE Act regulations in July, using a trust as an IRA beneficiary is still not a good idea. After the final regulations were issued, Ed Slott pointed out the reasons why.

Ten-year rule: The SECURE Act specifies that only eligible designated beneficiaries (EDBs) qualify for the “stretch” option, which allows beneficiaries to withdraw IRA assets for a period longer than 10 years. Surviving spouses qualify as EDBs, but most beneficiaries do not. Minor children of a deceased IRA owner count as EDBs, but grandchildren do not. Other EDBs include disabled and chronically ill beneficiaries, as well as other non-spouse beneficiaries who are not more than 10 years younger than the deceased IRA owner.

Disadvantages of the trust as beneficiary: The two disadvantages are high taxes and less trust protection. The trust you designate as an IRA beneficiary will be one of two types: a conduit trust or a discretionary trust. With a conduit trust, all required minimum distributions (RMDs) pass through the trust and are paid to the beneficiaries. With a discretionary trust, Slott points out, the trustee has the flexibility to determine whether the RMDs will be “paid to the trust beneficiaries, retained in the trust for protection, or held for successor beneficiaries.”

Regardless of which type of trust you use, the inherited funds will usually fall under the 10-year rule and have to be disbursed within a decade of the year the IRA owner dies. With a conduit trust, the beneficiaries will pay income taxes at their personal tax rates. With a discretionary trust, the trust pays taxes at higher rates. For example, in 2024, if income exceeds $15,200 the tax rate would be 37%, but an individual would not be paying 37% until the income exceeds approximately $609,000. In either case, at the end of 10 years, there would be a large tax liability.

Changes in the regulations: There were two changes. The first change eliminated the requirement that the custodian had to submit documentation by October 31 of the year after the owner’s death. The second change allowed qualified (see through trusts) trusts to be split into sub-trusts after death, which provides an advantage to EDBs, allowing them to use the stretch option in some situations. However, even with these changes, conduit trusts would be facing high taxes, and the trust protections would be lost. With the discretionary trust, the funds would still have to be paid to the trust by the end of 10 years, and any funds remaining in the trust after that would be subject to high tax rates.

Bottom line: Even with the modest regulatory changes, there are more disadvantages than advantages naming the trust as an IRA beneficiary.

Better options
One option is to only use Roth IRAs. You convert your traditional IRAs to a Roth IRA. Although the inherited Roth funds are subject to the 10-year rule, when the inherited Roth funds are paid out of the trust, the distribution will be tax-free to the beneficiary. The trust will also have no tax liability.

Life Insurance option: A better option is the life insurance option, which is more flexible. You could withdraw the funds from your traditional IRA and pay income taxes at the current low rate, and use the proceeds to purchase life insurance. You would be facing a 10% early distribution penalty if you are younger than 59 1/2. Using this approach should result in more funds for the beneficiaries, as well as less taxes and more protection.

(Elliot Raphaelson welcomes your questions and comments at raphelliot@gmail.com.