How Does an IRA Trust Work?
An individual retirement account (“IRA”) trust allows you to save money for retirement in a tax-advantaged way. It is a revocable living trust designed for holding your IRA accounts for your loved ones after your death. IRAs allow you to save for retirement with tax-free growth on a tax-free basis. You can also establish different sub-trusts within the IRA trust for the benefit of your beneficiaries, including your spouse. You can design each sub-trust to fit the unique needs of each beneficiary.
Why put an IRA in a trust?
Many people decide to put an IRA in a trust to have control over the disposition of the assets after he or she dies. For example, the IRA owner may want the assets to be disbursed according to a certain schedule instead of in a lump-sum payment. The IRA owner may also want some of the assets to be used for a specific purpose, such as financing the beneficiary’s education. The trustee of the trust would then be responsible for complying with the trust provisions.
What is a stretch IRA trust?
A stretch IRA occurs when a beneficiary is eligible to “stretch” the required minimum distributions over a longer period of time based on his or her life expectancy, which is determined by the applicable IRS life expectancy table. However, recently the Secure Act was passed by the House of Representatives that replaces the stretch IRA with a 10-year payout for most non-spouse beneficiaries, including trusts.
There are 3 main types of IRAs that have different advantages.
Traditional IRAs allow for contributions to be taken as tax deductions in the tax year they are made. They will reduce your gross income and reduce whatever tax burdens you may have. The contributions and earnings are both tax-deferred until the funds are withdrawn. This will help individuals whose tax rate will decrease between the time the money is deposited and the time the money is withdrawn.
Nondeductible IRAs have the advantage of reducing tax-deferred growth of contributions and earnings. They give individuals who do not meet traditional IRA criteria an investment option. Individuals must begin withdrawing from a traditional or nondeductible IRA during the year in which they turn 70 so that funds will be depleted based on life expectancy for their age.
Roth IRAs are different from the other types. Contributions that are made become taxed as income in the year they are deposited.
At the time of withdrawal, Roth IRA contributions are not taxable. After age 59, all or part of a Roth IRA may be withdrawn income tax-free and without penalty. Under certain circumstances, the IRS allows penalty-free and tax-free early withdrawals on Roth IRAs. The withdrawals, however, must be used for a qualified purpose. Your first withdrawal cannot be made until five years after you have opened the account. These can be used to buy your first home or college tuition.
Rollover IRA accounts are assets that were formerly in a 401(k) count from a previous employer that are “rolled over” into an IRA. Federal law provides important protection for qualified retirement plans. Your qualified retirement plan is protected by the Employee Retirement Income Security Act of 1974 (ERISA) from claims by creditors. This protection covers most employer plans, such as 401(k)s, defined benefit plans, and more.
A rollover IRA of any is protected from creditors under federal bankruptcy law. Which means, that rolled over money from an employment plan to an IRA is protected from creditors. This protection also applies to an SEP or a Simple IRA.
A contributory IRA (that is, an IRA that isn’t a rollover IRA) is also protected from creditors under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, up to one million dollars. The one-million-dollar limitation is indexed for inflation every three years, and currently is at $1,283,025.
But these federal protections for IRAs are available only in a federal bankruptcy action, which means that you must file for bankruptcy to protect the IRA.
It should be noted that the United States Supreme Court ruled a few years ago that inherited IRAs do not receive this protection. Only the original owner is protected. That ruling caused a number of estate planners to recommend people to consider naming trusts, instead of individuals, as IRA beneficiaries when they’re concerned that the intended beneficiaries might have problems with creditors.
The ERISA protection for employer plans, including 401(k)s, is provided whether or not you file for bankruptcy.
Florida offers more protection to its residents than the United States Supreme Court. Under Florida Statute 222.21, both IRAs and Roth IRAs are completely protected by debtors in bankruptcy and in civil judgments.