If you want to name adults as the beneficiaries of your IRA, we recommend you name them individually on your IRA beneficiary designation form. Do not name your living trust as your beneficiary.
One of your estate planning goals should be to make life less difficult for the successor trustee of your living trust. Naming individuals as your IRA beneficiaries keeps things simple.
The exception is if you have young or irresponsible children and you need a successor trustee to manage their inherited IRA. But if your beneficiaries are responsible grown-ups, it is better to simply name them individually as your IRA beneficiaries.
If you name your living trust as the beneficiary of your IRA, your successor trustee and her accountant will have to sort out the income tax issues - does the trust pay the income taxes, or do the individual beneficiaries pay their share of the tax? Also, it will be more difficult for your financial advisor and financial institution to process their paperwork to identify the beneficiaries from your trust, and this will delay your beneficiary's access to the funds.
If you name individuals, and not your living trust, as beneficiaries of your IRA, then when you pass away, each individual beneficiary can contact your financial advisor and make their own decision about how they want to receive their share of your IRA.
Your IRA beneficiaries will have two options to receive their share of your IRA:
1. Create an Inherited IRA. An inherited IRA is like a traditional IRA in that it can grow tax-free, and the distributions are taxable income. But unlike a traditional IRA, the beneficiary must take out all the funds within ten years.
Your beneficiary can choose the timing of his or her distributions. She can take annual distributions once a year for ten years. She can wait until she retires and is in a lower tax bracket and then take the distributions. Or, she can keep the funds growing tax-free for ten years and, on the last day of the tenth year, take it all out. Whatever she wants. But the distributions are taxable, and she must report them on her 1040.
2. Take the money and run. If your beneficiary takes his share of the IRA in a lump sum, he will have to report it all as income on his 1040. From an income tax perspective, this is not the best choice, but if he needs the money now - for a downpayment on a house, to start a business, or to pay off debt, he can use it now.
One of our primary objectives in estate planning is to keep things simple. Unless there is a reason to name your living trust as a beneficiary of your IRA (such as if you have young children), then it is simpler to name individuals as your IRA beneficiaries.