QUESTION:

What are the consequences of making my trust the beneficiary of my traditional individual retirement account?

ANSWER:

There are a couple of common reasons for naming a trust as beneficiary of an IRA. One is to maintain control -- to ensure that the assets of the IRA are distributed according to the same plan that is set up in your trust. The other is to fund a bypass trust -- that is, to make sure that you can make optimum use of your estate tax exemption amount.

But there are plenty of disadvantages to naming a trust as beneficiary. For one thing, you will be funding the trust with pretax money, which means, even though you direct $500,000 of IRA money into the trust, the trust will not actually be funded with $500,000. It will be $500,000 less the taxes owed on the IRA when the money is distributed. In contrast, if you put $500,000 of cash in the trust, the trust is funded with the full $500,000 because the cash is after-tax money.

If you are married, another risk in naming a trust as beneficiary is that your spouse cannot automatically roll over your IRA into an IRA in his or her own name when you die. For a spouse to be able to do that, the spouse must be the beneficiary -- not the trust. Being able to roll over a deceased spouse's IRA is a huge advantage and one you should think twice about giving up.

It is possible to name a trust and still manage to roll over some or all of the IRA, but it will take a good lawyer to structure the trust and beneficiary designation properly. And even then, there are no guarantees. Some taxpayers have made it work, others have not.