IRAs vs. trusts: Examining taxes, new rules and client needs

Taxes, changing rules for retirement and inheritances, and the degree that families will need certain assets in their estate plans for a specific use could each affect their choice of vehicle.

Processing Content

So financial advisors and their clients must weigh those factors when deciding whether a Roth or traditional individual retirement savings account or a trust entity would better fit into their long-term plans, according to three experts. 

To be sure, the higher costs of setting up and administering a trust when compared to using an IRA mean that the comparison usually plays out among high net worth households that may have exposure to the estate tax when handing down their assets. But that’s not always the case, given the shifts in guidelines under the Secure Acts and the One Big Beautiful Bill Act.

“The largest factor when comparing the two is that an IRA is a savings-and-tax vehicle; the trust is a control-and-distribution vehicle,” Fahmin Fardous, financial planner with Philadelphia-based registered investment advisory firm Zenith Wealth Partners, said in an email. “The Secure Act has changed the landscape of an IRA significantly. If a nonspouse inherits an IRA, then the account must be depleted within 10 years, whereas a trust can continue for generations.”

READ MORE: How to raise fees without losing clients 

Asset and benefit protection

She and Eric Ludwig, the director of the Center for Retirement Income at The American College for Financial Services, cited the end of the so-called stretch IRA strategy for beneficiaries and the parents of a child with special needs as typical scenarios causing planners and clients to compare the two. 

Parents who “are the primary caregivers” often find a trust to be “much more helpful,” as a means of ensuring that an adult child will remain eligible for government benefits after they pass away, Ludwig said in an interview. 

Before navigating the process of creating a trust, though, advisors and their families should be asking whether adding “this extra complexity to their plan” with that entity is worth it, he said. Charitable donations could help heirs avoid the possible tax hits from IRA distributions entirely.

“Now, they have to spend that down over 10 years,” Ludwig said. “That beneficiary might not want that, so, in that case, that is where using a charity would be great for that.”

On the other hand, new caps on charitable deductions from the OBBBA could also come into play — even if the assets are held inside of a trust, according to Griffin Bridgers, a member focusing on estate planning, business succession and tax strategy at the Illumine Legal law firm.

Nevertheless, trusts still provide more protection from potential creditors in cases such as bankruptcy and divorce. And that advantage gained steam from a 2014 Supreme Court decision that removed the shield for most IRAs involved with bankruptcy proceedings, Bridgers noted.

“Ultimately that led to the solution that you could pay IRAs to a trust as a beneficiary, instead of paying them to an individual as a beneficiary. But that itself comes with some tradeoffs,” he said, citing the balance between the “more compressed brackets” for trust entities against a quicker requirement that the transfer must be completed within five years instead of a decade. “Any IRA distributions that come out are going to be taxed to the trust.”

READ MORE: LPL’s AI challenge: Moving fast without overwhelming advisors 

Make the choice, then avoid the shortcuts

Such signals from “life transitions” to “start the estate planning process” will prompt clients to consider IRAs and trusts, Fardous noted. And those decisions highlight why it’s important to remind clients to update their beneficiary designations after the birth of a child or grandchild, marriage or divorce, an inheritance or the sale of a business, home or another asset.

Tax-free investment growth and the deferral (in a traditional IRA) or post-duty withdrawals from Roth accounts offer “one of the most compelling advantages” over trusts, she said.

“Beyond taxes, IRAs are simply easier to establish and maintain; there are no legal drafting costs, no trustee fees and beneficiary designations are straightforward to set up and update,” she said. “IRAs pass directly to named beneficiaries. They avoid probate entirely without requiring the added complexity of a trust.”

Regardless, trusts bring more privacy and a home for more kinds of assets in one place, which can be especially useful for planning around divorces and families with children who have special needs.

“Where a trust truly shines is in the level of control and customization it offers,” Fardous said. “A trust allows the grantor to dictate precisely when distributions are made, how much is released, and for what purposes — a critical advantage when beneficiaries are young, financially inexperienced or prone to impulsive decisions.”

That edge over IRAs for estate planning, however, stems from “the trust agreement itself,” which must spell that out properly in line with the latest guidelines, Bridgers pointed out. The rising numbers of financial technology providers that are promoting their speedy creation of trust and will documents may not include all of “the necessary language” in those forms, he said.

“There is very specific language that has to be in the trust,” Bridgers added. “Having that language in the trust is key, and it’s the type of language that even many attorneys may not understand.”