by Archie M. Richards, Jr.
December 11, 2006

I've stated in previous columns that a living trust should be made the beneficiary of a person's IRA. The statement was true, but incomplete. The matter is explained more fully here. This column was drafted with the help of Bradley J. Frigon, tax and elder-law attorney, of Englewood, Colorado.

We're talking about traditional IRAs. With those, your earned income is not taxed before it's contributed to the plan. Beginning at your age 70½, the government requires minimum distributions, which it taxes.

First, we present possibilities if you do not have a living trust:

You should grant a power of attorney to a third party, to manage the IRA on your behalf in the event of your legal incompetence.

You might name your spouse as primary beneficiary of the IRA, to inherit after your death. She can treat your IRA as her own or roll it over to her own IRA. (The "spouse" can of course be a husband.) Consider, however, whether the spouse's beneficiaries after her death meet with your approval.

You'd probably name your children as secondary beneficiaries, to inherit if the primary beneficiary dies before you do.

If you die after reaching 70½ and your spouse has predeceased, the following are two commonly-used approaches for the children:

• Required minimum distributions of equal amounts are made to each of the IRA beneficiaries according to the life expectancy of the oldest of them.

• Required minimum distributions of different amounts are made to each beneficiary according to that person's individual life expectancy. This alternative enables younger beneficiaries to receive smaller distributions. Money stays in the IRA longer, reducing taxes and allowing the investments to continue compounding in a tax-free environment.

(The rules are different if you die before 70½. IRA inheritances are sinkholes of complexity. Get expert advice.)

Okay, now let's assume you have an IRA and a living trust:

You should still grant a power of attorney. The custodian cannot accept the authority of a successor trustee, because the trust is not yet the beneficiary. Although legally incompetent, you're still alive as owner.

You would probably name your spouse as primary beneficiary. (See the above caveat concerning her beneficiaries.)

As secondary beneficiary, you would name your trust.

Okay, we'll assume your spouse dies first. After attaining age 70½, you then die. The trust becomes the beneficiary, and the successor trustee takes over the IRA's management.

Say your trust document provides that the trust property splits into shares for the benefit of the children and their descendents, as is common. The trust receives the required minimum distributions from the custodian, and the trustee pays the money to the children.

But even though the trust is split into shares, the government requires that the IRA distributions be made in larger, equal amounts according to the life expectancy of the oldest beneficiary. With a trust, the IRS doesn't permit distributions of unequal amounts according to the life expectancy of each beneficiary. (All of the beneficiaries must be individuals. If any are charities, the rules are altogether different.)

Having to pay larger, equal amounts is a disadvantage. But it's still worthwhile to make the living trust the IRA's secondary beneficiary. Some of the beneficiaries may be minors. Others may have disabilities. (If the disabled are receiving government benefits, consult an attorney who specializes in "special needs" trusts.) Without your living trust providing for the beneficiaries, a probate judge would have to appoint guardians (who serve at high cost), to enable those individuals to inherit money.

A trust makes guardianship appointments unnecessary. The trustee doesn't necessarily pay money to minors or disabled persons. The trustee pays money and engages in other activities for their benefit. This capability outweighs the tax disadvantage of having to pay larger, equal amounts to each trust beneficiary.

Despite the tax disadvantage, a living trust enables the right amount of money to be paid to the right people in the right way at the right time with a minimum of cost, bother, and family conflict.