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Two trust options that protect an inherited IRA

If an IRA account represents a significant asset, you may want your child to receive it with as few penalties and as many protections as possible when you pass. Estate taxes and income taxes can take a chunk out of an inherited IRA, and if your child has debt issues, an inherited IRA does not have protection from creditors like a traditional IRA does.

In addition, although you must begin taking the required minimum distributions from your IRA at the age of 70 1/2, your beneficiary must begin taking them from an inherited IRA the year following your death. He or she must pay income tax on the amount received from the IRA.

To avoid these issues, you may be able to set up a trust to ensure that your IRA account reaches your beneficiary as you intend. 

Accumulation trust

Instead of naming your child as the beneficiary of your IRA account, you can create a trust and name it as beneficiary, instead. The trustee - who must be someone other than the beneficiary - does not have to take the required minimum distribution from this type of trust, so the assets can continue to accumulate interest.

The trustee can distribute the accumulated funds at his or her discretion. This discretion can include situations that are likely to diminish the funds, such as if the trustee knows that the beneficiary is going through a divorce and the funds would be subject to property division if the money leaves the trust. 

Conduit trust

The trustee would distribute funds to your child according to the required minimum distribution, if you set up a conduit trust as the beneficiary of your IRA. Your child would pay income taxes based on his or her tax rate. Like with an accumulation trust, the conduit trust owns the asset, so creditors or a vindictive spouse cannot access it in a lawsuit or divorce.

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