Whenever you deal with tax-favored accounts like IRAs, complex rules typically apply. From the perspective of the IRA beneficiary, taking care of getting assets transferred after the death of the original IRA owner involves avoiding several traps that threaten the beneficiary's ability to get maximum tax deferral by stretching out IRA distributions over the beneficiary's life expectancy. However, the primary responsibility for planning what will happen to IRA assets after death lies with the original owner. The IRA owner holds complete control over the eventual disposition of the IRA, through the power to name primary and contingent beneficiaries who will receive the assets after the owner's death. If the IRA owner makes mistakes in naming beneficiaries, the results can be costly.

Looking out for your heirs
The question of how to handle the transfer of money to your heirs after your death involves much more than just tax-related considerations. Giving money directly to family members is often the simplest way to transfer your assets, but it also requires the recipients to exercise self-control and have the predisposition and expertise to handle financial matters on their own. Many people who receive substantial inheritances have absolutely no idea how to manage money, or how to respond to the consequences that money can have on lifestyle and standards of living. In situations involving children, most parents worry that their children will spend the money quickly without regard to long-term financial needs. If IRA assets are left directly to children, nothing stops them from withdrawing the full amount of the IRA immediately, incurring significant income tax liability in the process. Furthermore, leaving money outright to minor children may require the creation of a court-supervised conservatorship, which can be expensive and burdensome.

In order to limit the recipient's ability to spend large sums of inherited money, and to avoid the necessity of naming a conservator, creating a trust for your children may be an attractive solution. In general, trusts allow you to specify exactly how you want the money within the trust spent, including the ability to list permissible purposes for the money. You can choose to distribute funds at certain ages or upon certain events, such as the completion of college education. You can even draft a trust to limit or defer distributions to beneficiaries, if circumstances make it unwise to make such distributions.

When IRA assets are involved, however, using a trust to hold an inheritance gets tricky. This article discusses what you need to do to make sure your trust can take advantage of the same tax benefits available to individual beneficiaries.

Qualifying your trust for lifetime distributions
The key to maximizing the tax benefits of IRAs that name trusts as beneficiaries is to make sure that the trust includes the provisions necessary to treat the trust beneficiaries as designated IRA beneficiaries for tax purposes. In addition, the provisions of the trust must give the trustee power to follow IRS rules for making minimum distributions. The trust must be a valid trust under state law, irrevocable after the IRA owner's death, and it must be possible to identify the specific trust beneficiaries from the trust document. The trustee must give basic trust information to the financial institution handling the IRA, including a list of trust beneficiaries and the language of the trust itself, including any amendments.

In determining the appropriate life expectancy over which distributions from the IRA must be made, you must use the age of the oldest trust beneficiary. If you have three children but just one trust, all of the children must take distributions using the life expectancy of your oldest child. On the other hand, if you have separate trusts for each child, naming each trust as a one-third beneficiary of your IRA, then the children can each use their own age to determine the rate at which they must take IRA distributions. Separating trusts can extend the life of an IRA by almost the same amount of time as the difference in age among beneficiaries. In cases involving beneficiaries of widely disparate ages, this can be quite valuable.

Although the trust can limit distributions of principal, the easiest way to ensure that you follow IRS rules is to include provisions that make the trust a so-called conduit trust. This means that the trust must not accumulate income, but rather must distribute any income to the trust beneficiary. For practical purposes, if your trust's only assets are interests in inherited IRA accounts, you must make sure that the trust will distribute the amount of required minimum distributions from the IRA to the trust beneficiaries outright. Although this sometimes runs counter to the wishes of the original IRA owner, required minimum distributions for young beneficiaries are generally so small -- between 1% and 2% for beneficiaries under 30 -- that the benefits from tax deferral outweigh the risk of indiscriminate spending of the distributed money.

Using other types of trusts as IRA beneficiaries
In order to meet all of the rules involved with trusts that are IRA beneficiaries, it's generally best to draft a separate trust that will only hold the IRA. However, there are situations in which IRA owners will wish to use other types of trusts, such as marital trusts or bypass trusts. Here, the need to meet not only the IRA-related trust rules, but also the rules relating to the marital or bypass trust itself, makes planning especially complicated. Before naming a marital or bypass trust as beneficiary of your IRA, you should consult with your estate-planning attorney to make certain that your beneficiary designation will not endanger your overall estate plan.

Protecting assets for your beneficiaries while getting long-term tax deferral can be extremely useful for IRA planning. Knowing and following the rules can make the difference between large tax savings and a huge tax bill for your loved ones.

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Fool contributor Dan Caplinger welcomes your feedback.