5 Costly Mistakes with Required Minimum Distributions (RMDs)

You have a revocable living trust to protect your family. You have retirement accounts to secure your future. But have you considered how these two pieces of your California estate plan work together? If you have named your revocable trust as the beneficiary of your IRA or 401(k), you may have unknowingly created problems with Required Minimum Distributions (RMDs) that could cost your family thousands in unnecessary taxes.

This is one of the most common estate planning mistakes we see at our Carlsbad office, and it often goes unnoticed until after someone passes away. The good news is that with proper planning, you can coordinate your retirement accounts with your trust to maximize tax deferral and protect your beneficiaries.

In this guide, we will explain the trust RMD rules that California families need to understand, the mistakes that can accelerate taxes on inherited retirement accounts, and how to structure your beneficiary designations correctly.

Why RMDs and Trust Beneficiary Designations Matter

Retirement accounts like IRAs and 401(k)s pass outside of your trust by beneficiary designation, not by the terms of your trust document. If you name your revocable trust as the beneficiary, the IRS applies special rules that can either preserve or eliminate favorable RMD treatment for your heirs.

Many California families assume that because they have a revocable living trust, all their assets should flow through it. This makes sense for real estate, bank accounts, and brokerage accounts. But retirement accounts are different. They already avoid probate through beneficiary designations, so the main reason to involve a trust is to control how and when your heirs receive the funds.

The problem arises when the IRS determines how quickly your beneficiaries must take distributions from an inherited IRA. The Required Minimum Distribution rules depend heavily on who, or what, is named as the beneficiary. Name an individual, and one set of rules applies. Name a trust, and a completely different, often less favorable, set of rules may apply.

How the SECURE Act Changed Trust RMD Rules

The SECURE Act of 2019 and SECURE 2.0 Act of 2022 fundamentally changed how inherited IRAs are distributed. Before these laws, beneficiaries could “stretch” distributions over their lifetime. Now, most non-spouse beneficiaries must empty inherited retirement accounts within 10 years of the original owner’s death.

This 10-year rule applies to most adult children who inherit retirement accounts from their parents. Only “eligible designated beneficiaries” can still stretch distributions over their lifetime. These include surviving spouses, minor children (until age 21), disabled or chronically ill beneficiaries, and beneficiaries who are not more than 10 years younger than the account owner.

For trusts, this creates additional complexity. The trust itself is not a person, so the IRS looks through the trust to identify the beneficiaries. If the trust does not meet specific requirements, or if it has a non-individual beneficiary (such as a charity) among its potential recipients, even stricter distribution rules may apply.

Current RMD Starting Ages Under SECURE 2.0

Five Common Mistakes When Naming a Trust as IRA Beneficiary

Naming your revocable trust as the beneficiary of your IRA is not inherently wrong, but doing it incorrectly can create significant tax consequences. Here are the five most common mistakes we see with California families.

Mistake 1: Naming the General Revocable Trust Instead of Specific Sub-Trusts

When you name “The Smith Family Trust” as your IRA beneficiary, the IRS must look at all potential beneficiaries of that trust to determine RMD rules. If your trust includes provisions for multiple children, grandchildren, and contingent beneficiaries, the age of the oldest potential beneficiary may determine the distribution timeline.

The better approach is often to name specific sub-trusts as beneficiaries of separate IRA accounts. For example, if your revocable trust creates separate trusts for each child upon your death, you can name “Trust for John Smith under the Smith Family Trust” as the beneficiary of one IRA and “Trust for Jane Smith under the Smith Family Trust” as the beneficiary of another.

Mistake 2: Including Non-Individual Beneficiaries in the Trust

If your trust includes a charity as a potential beneficiary, even as a contingent remainder beneficiary, the trust may not qualify as having a “designated beneficiary” for IRA purposes. Under Treasury Regulations, only individuals can be designated beneficiaries. A charity or other non-individual entity disqualifies the entire trust.

The consequence? If the IRA owner dies before their required beginning date and the trust has no designated beneficiary, all IRA funds must be distributed within five years. This compressed timeline can push beneficiaries into higher tax brackets and eliminate years of tax-deferred growth.

Mistake 3: Failing to Meet See-Through Trust Requirements

For a trust to be treated as a “see-through” trust (also called a “look-through” trust), it must meet four requirements under Treasury Regulation Section 1.401(a)(9)-4(f). If any requirement is not met, the IRS cannot look through the trust to identify the individual beneficiaries, and less favorable distribution rules apply.

Mistake 4: Not Understanding Conduit vs. Accumulation Trusts

Even if your trust qualifies as a see-through trust, the trust type matters. A “conduit trust” requires the trustee to distribute all IRA distributions to the trust beneficiary immediately. An “accumulation trust” allows the trustee to accumulate distributions within the trust.

The distinction matters because accumulation trusts require the IRS to consider all potential beneficiaries, including remainder beneficiaries who might receive trust assets after the primary beneficiary dies. If your trust names your elderly sibling as a contingent beneficiary, their age could determine the RMD calculation, even if your children are the primary beneficiaries.

Mistake 5: Ignoring the Oldest Beneficiary Problem

When a trust has multiple beneficiaries, RMDs are generally calculated based on the life expectancy of the oldest beneficiary. This is known as the “oldest beneficiary problem.” If your trust includes your 70-year-old brother as a contingent beneficiary and your 35-year-old children as primary beneficiaries, your brother’s shorter life expectancy could determine the distribution timeline.

The solution is often to split IRAs during your lifetime and name different sub-trusts or individuals as beneficiaries of each account. This allows each beneficiary’s distributions to be calculated based on their own circumstances rather than those of the oldest person in the group.

How to Coordinate Your IRA Beneficiaries with Your California Trust

The best approach depends on your family’s specific situation, but there are general strategies that work well for most California families. Here is a step-by-step process for reviewing and updating your IRA beneficiary designations.

Step-by-Step: Reviewing Your Retirement Account Beneficiary Designations

1. Gather your current beneficiary designation forms. Contact each financial institution that holds your retirement accounts and request copies of your current beneficiary designations. Many people are surprised to find outdated designations from decades ago.
2. Review your trust document. Understand how your revocable trust distributes assets upon your death. Identify who the beneficiaries are, whether there are any charitable provisions, and how sub-trusts are created.
3. Consider whether a trust is necessary for each account. If your children are responsible adults and you have no concerns about creditors, divorce, or spendthrift issues, naming them directly as beneficiaries may produce better tax results than naming a trust.
4. If a trust is needed, consider naming specific sub-trusts. Rather than naming your general revocable trust, work with your attorney to identify the specific sub-trust that should receive the retirement account and name that sub-trust as the beneficiary.
5. Consider splitting IRAs for multiple beneficiaries. If you want to leave retirement accounts to multiple people, consider creating separate IRAs during your lifetime and naming different beneficiaries for each. This avoids the oldest beneficiary problem.
6. Update beneficiary designations in writing. Complete new beneficiary designation forms with each financial institution. Keep copies of your estate planning documents.
7. Review periodically. Beneficiary designations should be reviewed whenever you update your estate plan, after major life events, and at least every three to five years.

When Does Naming a Trust as IRA Beneficiary Make Sense?

Despite the complications, there are valid reasons to name a trust as an IRA beneficiary. The key is ensuring the trust is structured correctly, and the benefits outweigh the costs.

Naming a trust as an IRA beneficiary may be appropriate when:

• Beneficiary has special needs: A special needs trust can receive IRA distributions without jeopardizing the beneficiary’s eligibility for government benefits.
• Beneficiary has creditor issues: Inherited IRAs receive limited creditor protection. A properly drafted trust can provide greater security.
• Beneficiary is a minor: A trust can manage distributions for minor children until they reach a specified age.
• Beneficiary has substance abuse or spending issues: A trust can limit access to funds and provide professional management.
• Blended family situations: A trust can ensure a surviving spouse receives income while preserving principal for children from a prior marriage.
• Asset protection is a priority: Trust provisions can protect inherited retirement funds from a beneficiary’s divorce or lawsuits.

Frequently Asked Questions on RMDs