Naming a Trust as a Beneficiary of Retirement Accounts

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Note: This is an update of an article that was originally published on May 6, 2019.

On July 18, 2024, more than two years after releasing its proposed regulations applicable to required minimum distributions (RMDs), the IRS released its final RMD regulations. The July 2024 release amends the rules and regulations governing RMDs from qualified retirement plans, 401(k) plans, 403(b) plans, governmental 457(b) plans, and individual retirement accounts (IRAs) to reflect changes made by the Secure Act of 2019 (Secure Act 1.0).

Secure Act 1.0 brought massive changes to the payout rules applicable to inherited retirement plans and IRAs. The most significant change was the elimination of the “stretch” IRA for most non-spouse beneficiaries, referred to as non-eligible designated beneficiaries (NEDBs), and replaced it with a new 10-year payout rule.

Secure Act 1.0 also had a sizable impact on those retirement account owners naming a trust beneficiary, creating new rules increasing the complexity of something that was already complicated. For example, Secure 1.0 created both eligible designated beneficiaries (EDBs) and NEDBs; where the former generally remain eligible to “stretch” distributions over their single life expectancy, while the latter is now subject to the new 10-year payout rule. In other words, it’s of significant importance whether some or all of a trust's beneficiaries are comprised of EDBs and/or NEDBs.

Trust Beneficiary

The owner of a retirement account (i.e., IRA, 401(k), 403(b), etc.) can essentially designate anyone or anything (i.e., estate, charity, or trust) to be their named beneficiary. Increasingly however, account owners are relying on their financial professional for advanced beneficiary-planning strategies, such as naming a trust as beneficiary of their retirement account. Designating a trust beneficiary is both tricky and complicated, with potential unintended consequences if not implemented and executed according to the myriad of IRS rules and regulations. Therefore, advisors and their clients need to be aware of the nuances and appropriateness of these arrangements. For those considering naming a trust beneficiary, it’s also crucial to partner with a seasoned attorney that is familiar with drafting a qualifying trust along with the new definition and rules contained in the IRS Final RMD Regulations published in July 2024.

An owner of a retirement account has a lot of latitude in naming their beneficiary. He/she could name a spouse, child, grandchild, friend, charity, estate, trust, or some combination thereof. When then, should someone consider naming a trust beneficiary? Although each situation depends upon family dynamics and therefore is unique to them, common situations for naming a trust beneficiary include: a beneficiary who is a minor; a disabled individual; second marriages; creditor protection; estate taxes; or a beneficiary who doesn’t have the financial acumen to manage his or her inheritance effectively. In addition, a trust can play a critical role in situations where the account owner has beneficiary “trust” concerns—here, a trust can protect a “spendthrift” from rapidly depleting an inheritance. Finally, and importantly, trusts do not save money on taxes; instead, the primary reason to name a trust as beneficiary is the control of (post-death) distributions to (trust) beneficiaries.

Designated Beneficiary

A designated beneficiary (DB) is any individual designated as a retirement account beneficiary. Importantly, only individuals (i.e., a person who has a life expectancy) who are named as a retirement account beneficiary can be a designated beneficiary. Notably, an individual excludes nonperson beneficiaries such as an estate, charity, or a non-qualified trust.

See-Through Trust

A trust is an entity, and therefore does not qualify as a designated beneficiary. However, the IRS’ final regulations confirm the concept of a “see-through” trust, thus allowing trust beneficiary(ies) to utilize their applicable RMD schedule. In other words, IRS rules allow for “seeing through” the trust and thus treat the trust’s beneficiaries as if they were the retirement account owner’s direct beneficiary. A “see-through” trust therefore becomes eligible to receive designated beneficiary treatment. Meeting “see-through” trust requirements allow a trust beneficiary to use the 10-year payout or stretch, depending on if they qualify as an EDB or NEDB.

To qualify as a see-through trust the following requirements need to be satisfied:

1. The trust is valid under state law.

2. The trust is irrevocable, or the trust contains language to the effect it becomes irrevocable upon the death of the retirement account owner.

3. Beneficiaries of the trust are identifiable from the trust instrument.

4. The final regulations that clarify documentation rules for trust beneficiaries only apply to employer-sponsored retirement plans (i.e., 401(k)s). Here, the trustee must provide documentation to the plan administrator consisting of either: 

a. The trust instrument itself, or

b. A list of all beneficiaries of the trust, along with a description of the conditions under which each beneficiary would be entitled to assets from the trust.

Required trust documentation must be provided by the trustee to the plan administrator by October 31 of the year following the year of the plan participant’s death.

Somewhat surprisingly, the final regulations eliminate the requirement to provide trust documentation to the IRA custodian. In other words, the documentation requirement for determining whether a trust meets the see-through requirements has been eliminated for trusts that are IRA beneficiaries. Therefore, the trustee of a see-through trust is not required to provide trust documentation to the IRA custodian.

What happens if a trust beneficiary fails to qualify as a “see-through?” Failing to meet the “see-through” requirements potentially results in the payout schedule being reduced to as little as five years! Why? As we noted in a previous article, when the retirement account owner named a beneficiary that is not an individual, such as a trust that does not qualify as a “see-through,” the beneficiary is deemed a “non-designated beneficiary.”

Who Is Considered a Trust Beneficiary?

The final regulations confirm which beneficiaries of a see-through trust are considered beneficiaries of a retirement account and those who can be disregarded. Making this determination first requires the trust to be a see-through trust and subsequently determining whether it qualifies as a conduit trust or accumulation trust. This determination will establish the applicable payout schedule (i.e., stretch or the 10-year rule).

Conduit Trust* – Where all distributions from the retirement account are required to be immediately distributed to the trust beneficiaries.

Importantly, only a primary trust beneficiary originally assigned to receive distributions is treated as a retirement account beneficiary. Whereas all additional (if any) trust beneficiaries are ignored for purposes of determining the retirement account's (post-death) distribution schedule (i.e., stretch or 10-year rule).

Accumulation/Discretionary Trust* – Where distributions from the retirement account can remain/accrue within the trust.

Here, both primary and residual beneficiaries are treated as beneficiaries of the retirement account. A residual beneficiary is one who could receive undistributed retirement account funds after the death of a primary beneficiary and is treated as a beneficiary of the retirement account.

There are, however, two exceptions:

1. When a Residual Beneficiary can only receive assets from the trust after the death of a Residual Beneficiary who has not predeceased the original account owner.

2. When a Residual Beneficiary can only receive assets from the trust after the death of a Primary Beneficiary to whom the trust was required to fully distribute its assets no later than the year of their 31st birthday (but who died before such distribution could occur).

Secure Act 1.0 created a new category of beneficiary—eligible designated beneficiary (EDB). Now there are three categories of beneficiaries—each classification has its own unique set of RMD rules.

1. Non-eligible designated beneficiary (NEDB): Any individual designated as a beneficiary. A NEDB excludes nonperson beneficiaries such as estates, charities, and certain trusts. We covered this category in an October 2024 column.

2. EDB: There are five types of EDBs including: surviving spouse, minor child of the account owner, disabled beneficiary, chronically ill beneficiary, and a beneficiary that is not more than 10 years younger than the account owner. Generally, an EDB can take minimum distributions based on their single life expectancy. We took a closer look at EDBs in this column from October 2024.

3. Non-Designated Beneficiary: A beneficiary without a life expectancy such as an estate, charity, or non-qualified trust. This category was featured in an August 2024 column.

Separate accounting occurs when an IRA with more than one beneficiary is “split” into separate inherited accounts for each beneficiary. When the split takes place by December 31 of the year following the year of the (account owner’s) death, the applicable RMD schedule will apply separately for each beneficiary. Previously, while separate accounting was allowed for multiple beneficiaries named directly on a retirement account beneficiary form, it was not permitted for a trust beneficiary—even when the trust qualified as a see-through trust.

The final regulations contain a new tax-payer-friendly feature allowing the retirement account beneficiary of a see-through trust to be divided into sub-trusts for each beneficiary immediately after the death of the retirement account owner. This is great news for see-through trusts with more than one beneficiary. Now, the RMD rules can be applied separately to each individual trust beneficiary according to their own individual status (EDB or NEDB). Previously, the RMD (for a see-through trust beneficiary) was determined using the individual beneficiary with the shortest required distribution payout schedule (i.e., the oldest beneficiary).

Separate accounting may be used for a retirement account trust beneficiary if the terms of the trust provide that it is to be divided immediately upon death of the account owner into separate accounts for each trust beneficiary.

For beneficiaries of a see-through trust to receive separate accounting treatment, the following requirements must be met.*

• To be eligible for treatment as a separate account, the trust must already be a see-through trust.
• The trust includes specific terms that it is to be divided immediately upon account owner’s death.
• There can be no discretion as to how a beneficiary’s account balance will be allocated to the sub-trusts after the (account owner’s) death. If that allocation is not specified, the funding trust (rather than individual sub-trusts) will be treated as the sole IRA beneficiary.
• Expansion of this rule to include all types of see-through trusts means—for trusts that are structured to divide into separate sub-trusts for each beneficiary—the fact that there may be NEDBs among trust beneficiaries would not cause any EDBs to lose their stretch treatment.

Should these requirements be met, each sub-trust is treated separately for the purposes of determining RMDs.

An IRA owner who named a see-through trust beneficiary dies. The trust beneficiaries include a NEDB and an EDB. The EDB might be eligible to “stretch” distributions using their single life expectancy, while the NEDB would be required to use the 10-year rule. Separate accounting allows each beneficiary to use their own RMD payout schedule.

Without separate accounting—all beneficiaries would have to use fastest payout method (i.e., 10-year payout).

Example (Separate Accounting):

Steven, age 55, dies owning a traditional IRA. He names his trust as beneficiary (it qualifies as a “see-through” trust). Steven names his three children, Nicole, age 12, Nina, age 22 (disabled), and Naomi, age 24, as trust beneficiaries.  Which RMD schedule applies to each beneficiary?

• Nicole, a minor child (of Stephen, the account owner) qualifies as an Eligible Designated Beneficiary (EDB), allowing her to stretch distributions based on her single life expectancy until she reaches age 21.
• Nina, a disabled beneficiary, also qualifies as EDB allowing her to stretch distributions based on her single life expectancy.
• Naomi is a designated beneficiary (DB) and therefore subject to the 10-year rule.

Due to the final regulations, each sub-trust can receive separate account treatment thus allowing each beneficiary to use his/her own RMD schedule.

When Do the Trust Beneficiary Rules Go into Effect?

On or after January 1, 2025. For years prior to 2025, a reasonable, good faith interpretation of the final regulations.

Conclusion

Both retirement account owners and their beneficiaries must be brought up to speed on the new definition and rules that apply to a trust, ensuring they are properly designed and in compliance with the new, final RMD rules.

Questions? Please contact your Lord Abbett representative at 888-522-2388.