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What you should know about trusteed IRAs

The tax code allows IRAs to be created as trust accounts, custodial accounts and annuity contracts. Regardless of the form, the federal tax rules are generally the same for all IRAs. But the structure of the IRA agreement can have a significant impact on how your IRA is administered. This article will focus on one type of trust account commonly called a "trusteed IRA" or "individual retirement trust."

Why might you need a trusteed IRA?

In a typical IRA, your beneficiary takes control of the IRA assets upon your death. There's nothing to stop your beneficiary from withdrawing all or part of the IRA funds at any time. This ability of your beneficiary to withdraw assets at-will may be troublesome to you for several reasons. For example, you may simply be concerned that your beneficiary will squander the IRA funds.

Or it may be your wish that your IRA "stretch" after your death—that is, continue to accumulate on a tax-deferred (or in the case of Roth IRAs, potentially tax-free) basis—for as long as possible. Your intent to stretch out the IRA payments may be defeated if your beneficiary has total control over the IRA assets upon your death.

Even if your beneficiary doesn't deplete the IRA assets, in a typical IRA you normally have no say about where the funds go when your beneficiary dies. Your beneficiary, or the IRA agreement, usually specifies who gets the funds at that point. So, in a typical IRA, if you name your spouse as your primary beneficiary, your spouse could name children from a previous marriage, or a new spouse if he or she remarries, as the ultimate beneficiary of your IRA assets. A trusteed IRA allows you to control the ultimate beneficiaries of your IRA, by letting you specify contingent beneficiaries that cannot be changed by your primary beneficiary.

With a trusteed IRA, you can't stop the payment of required minimum distributions (RMDs) to your beneficiary but you can restrict any additional payments. You can direct the trustee to pay only RMDs to your beneficiary. Or you can provide the trustee with discretionary authority to make payments to your beneficiary in addition to RMDs, e.g., for your beneficiary's health, welfare or education. Or you can impose restrictions on distributions that last only until your beneficiary reaches a specified age. Trusteed IRAs can also be set up to qualify as marital, QTIP and credit shelter (bypass) trusts, potentially simplifying your estate planning.

A trusteed IRA can also be a valuable tool during your lifetime. It can be structured so that if you become incapacitated, the trustee will step in and take over the investment of assets and distribution of benefits on your behalf, ensuring that your IRA won't be in limbo until a guardian is appointed.

Is a trusteed IRA right for you?

While trusteed IRAs can be as flexible as a particular trustee will allow (not all provide the same level of IRA planning services), they aren't right for everyone. The minimum balance required to establish a trusteed IRA, and the fees charged, are usually significantly higher than for other IRAs, making trusteed IRAs most appropriate for large IRA accounts. You may also incur attorney's fees and other costs.

And in some cases, another approach might be more appropriate. For example, you may be able to assure that your IRA "stretches" after your death by instead naming a trust as the beneficiary of your IRA. If specific IRS rules are followed, RMDs can be calculated using your trust beneficiary's life expectancy (this is commonly called a "see-through" trust).

See-through trusts are generally more expensive, and more complicated, than trusteed IRAs. It's important that you consult an estate planning professional who can explain your options and make sure you choose the right vehicle for your particular situation.