What is a Conduit Trust?
A conduit trust is a form of trust in which the trustee is expected to dispense all IRA allocations to the trust’s nominee beneficiaries. All IRA benefits must be made in a 10-year period after the death of the contributor's.
In the of case there being multiple beneficiaries, all IRA allocations must be completed to at least one or more of the trust’s beneficiaries in the same 10-year period.
The requirement for conduit trusts defeats the point of making a trust as the trustee has no power to collect the IRA dispersals.
Conduit trusts are particularly unsuitable in this post Secure Act era since everything would be required to be distributed to the beneficiary within 10 years.
Most Americans are familiar with an Individual Retirement Arrangements (IRA) account which is used to hold funds meant for your retirement.
IRA accounts are useful for retirement savings as they offer tax advantages for the account holder. According to the IRS, amounts in your traditional IRA (including earnings and gains) are not taxed until you take a distribution (withdrawal) from your IRA.
Despite these taxes, an IRA is a very good option for long terms savings because they let people choose whether to place their funds in stocks or retirement funds. This gives them the chance of higher returns than possible on cash placed in any other form of account.
Issues with IRA Accounts
A person’s IRA may be their largest asset, but IRAs are also one of the more intricate and tax oriented assets to invest in as they can be difficult to manage from a wealth development and transfer point of view.
But when properly managed, planned and prepared, IRAs can be a great choice for the owner's nominees.
Trusts can be a good option to reassign assets to loved ones as they provide a degree of security from creditors and help preserve the value of an estate for the beneficiaries.
However, after the passing of the Setting Every Community Up for Retirement Enhancement (SECURE) Act in 2019, some special requirements come into play if the main asset for beneficiaries are in an IRA.
Advisors plan and execute a plan for using trusts as IRA recipients. This usually involves preparing a trust agreement by a lawyer together with the CPA managing the account.
The intended trustee of the IRA is also included in the planning team since they will be responsible for carrying out the distributions specified in the trust.
IRA Distribution Rules for Living Account Holders
Internal Revenue Service (IRS) regulations demand that IRA owners (usually called participants) start withdrawing money from their IRA at 72. This age is also called the required beginning date or RBD.
However, participants can start withdrawing from the account at 59.5 years of age and these withdrawals will not be penalized for early distribution. As distributions are charged at the usual income tax rates, most individuals try to put off withdrawing money as long as they can in order to to delay the payment of taxes.
Some least distribution amounts have to be withdrawn over the participant's life. These obligatory dispersals are calculated from uniform life expectancy tables that the IRS uses.
These life expectancy figures were modified after the IRS revised its regulations in 2020 and were to be implemented from 2022. These new tables are adjusted to reflect longer life expectancy and will decrease the mandatory requirement amounts for annual withdrawal.
Death of the Participant
Different distribution rules apply at the death of an IRA participant. These guidelines vary according to whether the participant has reached the age of 72, and who is the account beneficiary.
Suppose a participant dies after the Required Beginning Date without withdrawing the mandatory minimum distribution. In that case, the recipient nominated in the IRA must take it by year-end. The amount of the withdrawal is what the account holder was supposed to withdraw if they had lived.
Designated Beneficiaries Trusts
A trust can become nominated as a Designated Beneficiary, even though it is not an individual. There are some requirements which allow the proposed trust’s beneficiaries to become Designated Beneficiaries which have to be satisfied for a trust to be eligible:
The trust should be registered under the state’s legislature.
The trust is binding or will be binding subsequent to the participant's expiry.
The beneficiaries of the trust should be listed in the trust document.
There are some documents which should be submitted by October 31 of the year after the participant’s demise. These have to be submitted to the IRA plan administrator .
Points 1, 2 and 4 are easy to satisfy, but requirement 3 can generate multiple tax problems depending on how the beneficiaries are listed.
This PDF from the IRS shows a work through of a similar example which can be a good starting off point to learn more.
Identifying Trust Beneficiaries
A trust beneficiary doesn't need to be identified by name which means that it is okay to mention a group of beneficiaries for example children, nieces and nephews, or grandchildren.
However, once the participant dies, the particular individuals need to be specified by September 30 of the year after the account holder’s death. This detailed beneficiary listing is necessary for the trust to be considered a designated beneficiary and eligible for the 10-year rule.
Based on the volume of requirements, using a conduit trust as the recipient of an IRA is not a convenient option. The simplest option is to create a trust of all other assets and keep the IRA for clear allocation of assets to their selected beneficiaries and charities. This is, however, not a very convenient or useful option.
Users also have the alternative to transfer their conventional IRA into a Roth IRA and sidestep the tax impact on the allocations to the trust and its beneficiaries. However, this step entails careful evaluation as the participant will have to pay the accumulated income tax on their IRA at the time of conversion.
You can read more about Roth 401k vs 401k for High Income Earners here.
If there is no alternative but to leave IRA assets in a trust meeting with a team of advisors is vital. The beneficiary trust will require careful drafting to avoid potential pitfalls—a cost-benefit analysis of the tax consequences and benefits of making the trust needs to be done.
You might be also interested in Private Purpose Trust Fund and What is a Silent Trust?