If you have assets valued at $200,000 or more in an IRA, then you should consider setting up a special type of revocable living trust that's designed to be the beneficiary of your IRA. Why? For the following reasons:
Stretch IRAs - Creating a Legacy for Your Family
If your IRA is left directly to your beneficiaries outside of a trust, then your beneficiaries can immediately cash out your IRA and spend the money as they see fit. What happens if a beneficiary chooses this option? Then not only is a stretch out of the required minimum distributions, or RMDs, over the beneficiary's remaining life expectancy lost, but 100% of the amount withdrawn will be included in the beneficiary's taxable income in the year of withdrawal.
A different type of problem can be created if you name your minor grandchild as the direct beneficiary of your IRA. If this is the case, then a guardianship or conservatorship will need to be established to manage the IRA for the benefit of the grandchild until he or she reaches the age of 18. Then, once the grandchild reaches 18, he or she can withdraw 100% of what's left in the IRA.
On the other hand, if your IRA passes to your beneficiaries through an IRA Trust, then you can put restrictions on how your IRA is spent and when and how much the beneficiary can withdraw. This can create an ongoing legacy for your family since the IRA assets that aren't used during a beneficiary's lifetime can continue in trust for the benefit of the beneficiary's descendants. This can also be important if the beneficiary already has a taxable estate since the IRA Trust can be drafted to minimize or even eliminate estate taxes in the beneficiary's own estate.
An IRA Trust can also be used to insure that the RMDs are stretched out over the entire lifetime of each of your beneficiaries, thereby preserving assets left in the IRA for the benefit of future generations.
Aside from these benefits, if you're in a second or later marriage and want your current spouse to have access to your IRA but insure that what's left after your spouse dies goes to your children or other beneficiaries, then an IRA Trust is a must for you.
Providing Asset Protection for Your Beneficiaries
In many states IRAs are protected by applicable state laws from the claims of creditors with regard to the IRA account owner. However, once the IRA account owner dies and the IRA assets get into the hands of an individual beneficiary, the IRA assets will lose their protected status.
On the other hand, IRA assets passing into a subtrust created for the benefit of an individual beneficiary under the terms of an IRA Trust will continue to be protected. This will insure that the IRA assets will remain intact for the benefit of the beneficiary in the event a lawsuit is filed against the beneficiary, if a married beneficiary later divorces, or if a single beneficiary gets married and later divorces.