Making a living trust the beneficiary of a Roth IRA

A Roth IRA is a retirement account that you fund with after-tax dollars and use as an income source during retirement. It's possible to set up your Roth so that, upon your death, it pays the balance into a living trust that will then distribute the Roth funds to your heirs.

Understanding living trusts

A living trust is a trust you create during your lifetime. You transfer assets into the trust, so that the trust legally owns them, but you are able to continue using, spending, and enjoying the assets during your lifetime. Most living trusts are revocable, which means you can make changes to them or dissolve them as you wish.

After your death, the trust assets are paid out to the beneficiaries you have named, according to the timeline and schedule you have chosen. The assets in the trust do not go through probate, and your financial decisions stay private, as opposed to when you specify them in a will.

Understanding Roth IRAs

A Roth IRA is a retirement account that you fund with after-tax dollars. In contrast, a traditional IRA or a 401(k) is funded with pretax dollars.

A Roth can be managed by you—which is called a self-directed Roth—or by an investment professional. The money grows in the account and then is paid out to you during your retirement years. So long as you have had the Roth for at least five years and you are at least 59 ½ years old, withdrawals from the account are tax-free.

How to set up a living trust as a Roth beneficiary

There are two steps you'll need to take to have your Roth pay into a living trust:

• Set up your living trust. This must be done using a trust document and in accordance with the laws of your state.
• Designate the trust as the beneficiary for your Roth IRA. The Roth administrator can give you the form you need to do this.

Once you do this, the Roth will automatically be payable to the trust upon your death.

Benefits of naming a trust as your Roth beneficiary

When you pass your Roth IRA through a living trust, your beneficiaries will receive the Roth assets tax-free. Doing this also allows you to "stretch your IRA."

When a traditional IRA is paid out in retirement, there are Required Minimum Distributions (RMDs). This means you must start taking money out of the traditional IRA after you turn 70 ½ years old.

The yearly distribution amount that is paid is determined by dividing the value of the IRA by the years left in your life expectancy. With a Roth IRA, you can leave the money in the account, as there are no required distributions until after the death of the owner.

When you set up a living trust as the Roth beneficiary, you can stretch out the payments over a longer period of time.

After you die, the money in the Roth is not just handed over to your designated beneficiaries. Instead, it is gradually paid out — allowing it to earn and compound interest longer — according to the life expectancy of the oldest heir at the time of your death.

So, if the trust has your two grandchildren as beneficiaries, ages 10 and 11, the yearly amount paid out is determined by dividing the amount in the fund by the years left in the life expectancy of the 11-year-old.

As an example, if there is $100,000 in the Roth at your death and the 11-year-old grandchild has a life expectancy of 85, you divide $100,000 by 74, the 85-year expectancy minus the current age of 11. So the total yearly distribution amount would be $1,351, split between the grandchildren.

Having your living trust as the beneficiary of your Roth IRA can provide income for your heirs and maximize your remaining retirement funds. It is important that you work with an attorney and a tax professional to make sure it makes sense for you and to better understand the tax impact.