For a lot of families, an IRA or 401(k) is the largest thing they own. Sometimes it’s worth more than the house. It took decades to build, and it’s natural to want it to keep doing some good after you’re gone. That’s usually when someone asks whether they should name a trust as an IRA beneficiary instead of leaving it straight to their kids.
It can be a smart move. It can also cause real trouble if the trust wasn’t drafted with retirement accounts in mind, and plenty of older trusts weren’t. The federal rules for inherited retirement accounts changed a few years ago, and the IRS finished the regulations that go with them in 2024. A plan that made perfect sense ten years ago may not work the way its owner expects today.
Below is how the current rules work, where a trust fits, and what to look at if you already have one.
How Inherited Retirement Accounts Work Now
For a long time, a child or grandchild who inherited an IRA could spread withdrawals over their own life expectancy. The money left in the account kept growing tax-deferred for decades. That long payout is what people meant by stretching an IRA, and it’s the reason trusts built around retirement accounts became popular.
That option is now limited to a smaller group of people. Most beneficiaries other than a spouse have to empty an inherited account by the end of the tenth year after the owner’s death. If the owner had already reached the age where they had to start taking their own required distributions, the beneficiary generally has to take annual withdrawals in years one through nine as well, then clear out whatever is left in year ten. The IRS waived penalties on those annual withdrawals for 2021 through 2024, and it expects them to be taken starting in 2025.
The tax code calls the smaller group eligible designated beneficiaries, and they can still take distributions over their life expectancy. That group includes a surviving spouse, the account owner’s own minor child, a beneficiary who is disabled or chronically ill under the IRS definitions, and a beneficiary who is not more than ten years younger than the owner, which often means a sibling or a partner close in age. A minor child only keeps the longer schedule until age 21, and then the ten year clock starts. Grandchildren don’t fall into the minor child category, even when they’re young.
Roth IRAs follow the same timing rules. The difference is that qualified withdrawals from an inherited Roth are generally free of income tax, which changes the thinking about when to take the money out.
For everyone outside that group, the planning question now centers on who controls the money during those ten years and what happens to it once it comes out.
Why Name a Trust at All
If a large IRA goes straight to a 24 year old, that young person could have a lot of money in hand quickly, and nothing stops them from pulling all of it in the first year. Withdrawals from a traditional IRA are taxed as ordinary income in the year they come out, so cashing out early can push a beneficiary into a much higher bracket.
A trust lets you set the terms. The trustee decides when withdrawals come out over the ten years, which can help spread the tax bill across several years, and the trust document says how the money is used once it’s out of the account. Families usually reach for a trust when a beneficiary is young or not great with money, is in a shaky marriage, has creditor or addiction problems, or receives public benefits like Medicaid or SSI. Blended families use them too.
Creditor protection is worth its own mention. In 2014 the U.S. Supreme Court decided in Clark v. Rameker that an inherited IRA is not a protected retirement fund under the federal bankruptcy exemption. The protection available under state law depends on the facts, so a trust with spendthrift terms can add a layer that doesn’t hinge on how a court reads an exemption statute.
Conduit Trusts and Accumulation Trusts
A conduit trust requires the trustee to pass every distribution it takes from the IRA straight through to the beneficiary. It’s simple, and the income is taxed at the beneficiary’s own rate. Under the ten year rule, though, a conduit trust means the entire account reaches the beneficiary within about ten years, so the protection is temporary. That may suit a responsible 40 year old just fine. For a 19 year old who struggles with money, it’s probably not what the parent had in mind.
An accumulation trust lets the trustee hold distributions inside the trust instead of paying them out. The protection lasts as long as the trust says it does, which can be many years. The trade-off is income tax, because a trust reaches the top federal bracket at a small fraction of the income level that applies to an individual.
Many plans land somewhere in between, giving the trustee discretion to pay out or hold back depending on how the beneficiary is doing. The drafting has to be careful either way. To get the favorable treatment, the trust generally has to be valid under state law, become irrevocable at the owner’s death, and have beneficiaries who can be identified from the trust document. For employer plans like a 401(k), the plan administrator also needs a copy of the trust or a list of its beneficiaries by October 31 of the year after the owner’s death. A trust that misses these points can end up with a faster payout than anyone intended.
Special Needs and Chronically Ill Beneficiaries
This is where a trust built for retirement accounts still does some of its most useful work. A beneficiary who is disabled or chronically ill can still take distributions over their life expectancy, and that can hold true when the account passes through a trust, as long as the trust is written so that no one else can receive the retirement money during that beneficiary’s lifetime.
Paired with supplemental needs terms, the trust can use those distributions to improve a person’s quality of life without knocking them off Medicaid or SSI. If you have a family member in this situation, our special needs planning page covers the broader picture.
What About a Surviving Spouse
A surviving spouse still has the most flexibility under the rules, including the option to roll an inherited account into their own IRA and delay distributions. Naming a trust for a spouse can give up some of those options, so it tends to make sense in specific situations, such as a second marriage where the owner wants income for the spouse and the remainder protected for children from a first marriage, or a spouse who would need help managing a large account.
If You Already Have an IRA Trust
Trusts drafted before the rules changed deserve a fresh look. Some older conduit trusts were written expecting small payouts over a beneficiary’s lifetime and now push the full account out within ten years. Others refer to life expectancy schedules that no longer apply to the beneficiaries named. The trust may still be valid and simply not do what you wanted anymore.
The beneficiary designation form matters just as much as the trust. The form you filed with the IRA custodian or plan administrator controls where the account goes, regardless of what your will says. It needs to name the trust correctly, list contingent beneficiaries, and reflect your life as it is now. Colorado law can revoke some beneficiary designations after a divorce, but federal law controls many employer plans, so the safer course is to update the form yourself after a marriage, divorce, birth or death in the family.
It’s also worth looking at how the retirement account fits with the rest of your plan, including your trusts and your will. Retirement accounts often make a good fit for charitable gifts, because a qualified charity doesn’t pay income tax on what it receives, while other assets can go to family.
What to Think About Before a Planning Meeting
It helps to come in knowing who you want to benefit, how old they are, and how each of them handles money. Know roughly what sits in each retirement account, whether any of it is Roth money, and who is named on each beneficiary form today. Think about whether anyone has a disability, receives public benefits, or is going through a divorce. And think about what matters more for each person, a lower tax bill or longer protection, because those two goals sometimes pull in different directions.
You can read more about how this planning tool works on our IRA stretch trust page.
Talk It Through With Meurer & Potter
Meurer & Potter has helped Colorado families with estate planning since 1991. We offer a free consultation to new clients. You can contact our office or call 303-991-3544. Our office is at 5347 South Valentia Way, Suite 335, in Greenwood Village.
This article provides general information about Colorado estate planning and federal tax rules as of its publication date. It is not legal or tax advice, and reading it does not create an attorney-client relationship. Tax laws and IRS guidance change, so please speak with an attorney and your tax advisor about your own situation before making decisions.
