Using Retirement Trusts to Protect and Transfer IRAs

An effective estate plan should cover a client’s entire financial picture, but we frequently work with new clients whose plans don’t consider their individual retirement accounts (IRAs) as part of a broader IRA estate planning strategy.

Why IRAs are often overlooked in estate planning

Many estate‑planning practitioners overlook IRAs for two apparent reasons: (1) a trust can’t own an IRA during the account owner’s lifetime, and (2) retirement plans typically pass at death by beneficiary designation rather than by the terms of the account owner’s trust or will. As a result, estate planning for IRAs is sometimes treated as an afterthought.

But just because a different set of rules governs these accounts — compared with assets like real estate, cash accounts, and taxable brokerage accounts — doesn’t mean IRAs are any less deserving of the same careful consideration when designing an estate plan or developing IRA estate planning strategies.

Below we review a comprehensive estate‑planning approach for transferring IRA assets to beneficiaries in the most tax‑efficient way.

Why name a trust as an IRA beneficiary

One of the most important considerations when designing an estate plan is how the assets, including IRAs, will be transferred to beneficiaries in the future. While retirement accounts like IRAs often pass by beneficiary designation, using retirement trusts as part of an IRA estate planning strategy can offer greater control, protection, and tax efficiency. In many cases, this involves naming a trust as an IRA beneficiary rather than leaving assets outright.

Leaving assets to beneficiaries in a trust, rather than outright, can be beneficial for several reasons. A properly structured IRA trust can protect beneficiaries against a variety of concerns and allow a designated trustee to manage the trust property on their behalf. Certain retirement trusts can also provide an added layer of asset protection that may not apply if the beneficiary owns the inherited IRA directly.

How retirement trusts protect and transfer IRAs to beneficiaries

Before diving into the different types of trusts used in estate planning for IRAs, consider this example of an estate that has substantial IRAs and multiple beneficiaries with unique needs:

• H and W are married and have three children: Child 1, Child 2, and Child 3.
• Child 1 is married, but H and W have concerns about the marriage and about Child 1’s spouse, who has already been through one bankruptcy prior to the marriage and has questionable money management skills.
• Child 2 has special needs, currently lives independently, and doesn’t receive Medicaid or any other means‑tested benefits program, although they may in the future.
• Child 3 is a minor who lives with H and W.

Their estate includes the following assets:

Primary residence	$500,000
Vacation house	$500,000
Bank accounts	$100,000
Brokerage accounts	$600,000
Life insurance	$800,000
Business in LLC	$1,000,000
H’s SEP IRA	$1,500,000
W’s SEP IRA	$1,500,000

H and W’s estate plan consists of a revocable living trust and an irrevocable life insurance trust (ILIT). The revocable trust owns their primary residence, vacation house, bank accounts, and taxable brokerage accounts and is the sole member of the limited‑liability corporation (LLC). The ILIT owns the life insurance policy.

Their estate‑planning attorney recommended this structure so that the revocable trust assets could avoid probate at H and W’s deaths and the ILIT assets wouldn’t be subject to estate tax. Both trusts create irrevocable asset‑protection trusts for all three children after H and W pass away, including a standby special needs trust for Child 2.

H and W’s estate‑planning attorney also advised them to simply name each other as the primary beneficiary of their respective SEP IRAs, with the children named as contingent beneficiaries. The attorney explained that these IRAs are not subject to probate because they pass through beneficiary designation and assumed they would remain protected from creditors.

Types of trusts used in IRA estate planning

This approach for H and W creates several problems related to trusts and inherited IRAs.

Inherited IRAs are not necessarily protected from creditors or divorce. A 2014 U.S. Supreme Court decision confirmed that while retirement accounts may be protected during the owner’s lifetime, those protections generally do not extend to beneficiaries.¹

Leaving IRAs outright to beneficiaries could expose Child 1 to creditor or marital claims, force Child 3’s inheritance into a custodial account until reaching majority, and jeopardize Child 2’s eligibility for means‑tested benefits. By contrast, transferring IRAs to beneficiaries through a trust can address these risks while aligning retirement assets with the broader estate plan.

Naming a trust as an IRA beneficiary: Tax and distribution rules

We’re frequently asked: Can a trust be named as an IRA beneficiary? Unless prohibited by the plan administrator, the answer is generally yes. However, naming a trust as an IRA beneficiary introduces complexity around taxation and required minimum distribution (RMD) rules.

If a trust satisfies certain IRS requirements, it will be disregarded for RMD purposes and the individual trust beneficiaries will be treated as the IRA beneficiaries. If it does not, the IRA may be treated as though no beneficiary were named — often resulting in accelerated distributions and higher income taxes.

Under the SECURE Act, most designated beneficiaries are subject to the 10‑year rule for inherited IRAs, which requires full distribution within ten years.² While less favorable than the pre‑SECURE Act “stretch” rules, the 10‑year rule is still preferable to the five‑year rule that applies when the beneficiary is an estate, charity, or nonqualifying trust.

To preserve favorable tax treatment, a trust named as an IRA beneficiary must:

1. Qualify as a see‑through trust under IRS rules, and
2. Be drafted to allow beneficiaries to apply their own RMD rules under the separate account rules.

Qualifying as a see‑through trust for inherited IRAs

Although a trust itself can never be a “designated beneficiary” of an IRA for RMD purposes, a properly drafted trust may still qualify as a see‑through trust, allowing RMDs to be determined based on the individual beneficiaries’ life expectancies.

To qualify, the trust must:

• Be valid under state law
• Be irrevocable (or become irrevocable at death)
• Have identifiable individual beneficiaries
• Provide required documentation to the plan administrator within specified time limits⁴

The most common failures involve beneficiary identification — particularly when trusts name estates or charities, either directly or through boilerplate language directing payment of estate expenses. Because estates and charities lack a determinable life expectancy, even one such beneficiary can disqualify the trust.

Maintaining separate account treatment for inherited IRAs

Even a see‑through trust may fail to preserve optimal tax treatment if it does not allow separate account treatment.

Separate account rules permit each beneficiary to determine RMDs independently.⁵ To qualify, the trust must create separate shares for each beneficiary and the IRA beneficiary designation must name those separate trust shares, not the trust as a whole.

Failing to do so can force all beneficiaries to use the life expectancy of the oldest beneficiary, accelerating distributions and increasing income‑tax burdens.

Practical considerations when using a trust as an IRA beneficiary

Any trust named as an IRA beneficiary should be drafted specifically as a retirement trust. General‑purpose revocable trusts frequently fail due to charitable beneficiaries, common‑pot structures, or provisions that conflict with RMD requirements.

For this reason, a beneficial way to protect and transfer IRAs is through a retirement trust designed solely to hold retirement assets — one that qualifies as a see‑through trust, creates separate shares, permits RMD compliance, and clearly signals its limited purpose to future advisors.

Conclusion

When structured properly, a retirement trust can be a beneficial method for protecting and transferring IRAs to beneficiaries while preserving tax efficiency and long‑term planning intent. These trusts can help manage distribution timing, reduce exposure to creditor and divorce risk, and align retirement assets with the broader estate plan.

If an estate plan relies on trusts to govern how assets are managed and distributed, but IRAs, 401(k)s, or other retirement accounts are excluded from that structure, it may be worth revisiting whether those accounts are integrated appropriately. Careful coordination between trust design and IRA beneficiary designations is essential to achieving the intended outcomes.

To help determine whether a retirement trust could be beneficial for your situation, speak to your Mercer Advisors Wealth Advisor. Not a client but want more information about the options for including retirement accounts in your estate plan as they relate to your financial plan? Let’s talk.