It's generally a bad idea to name a trust as beneficiary of your IRA. The IRA usually loses the power of tax deferral, because it must be distributed faster than in other scenarios.
Forbes' recent article entitled “Should A Living Trust Be Beneficiary Of Your IRA?” explains that the general rule is when an IRA beneficiary isn't an individual, the IRA must be distributed fully within five years. When a trust, an estate, or a business entity is named beneficiary, the IRA must be distributed and taxed quickly.
There's an exception when you name a trust that qualifies as a “look-through” or “see-through” trust under IRS regulations. You need an experienced estate planning attorney to draft this trust to make certain that it avoids the five-year rule. Nonetheless, the IRA must be distributed to the trust within 10 years in most situations.
Another exception from a recent IRS ruling shows there might not be a penalty when your spouse's revocable living trust is named as the IRA beneficiary. The ruling involved a married couple. One spouse (the husband) owned an IRA and had begun required minimum distributions (RMDs). He died and had named a trust as sole beneficiary of the IRA. His wife had previously established the trust. She was the sole beneficiary and sole trustee of the trust. She had the right to amend or revoke the trust and could distribute all income and principal of the trust for her own benefit. Therefore, it was a standard revocable living trust primarily used to avoid probate. The widow wanted to exercise the spousal option for an inherited IRA and roll the IRA over to an IRA in her name. This would give her a fresh start, allowing her to manage the IRA without reference to her late husband's IRA. She could start RMDs based on her own required beginning date and life expectancy. The widow also could name her own beneficiaries of the IRA.
The widow asked the IRS to rule that the IRA could be rolled over tax free into an IRA in her name. She planned to have the IRA balance distributed to her directly, so she could roll it over to an IRA in her own name within 60 days. The IRS said yes and noted that the widow was the trustee and sole beneficiary of the trust, so she was entitled to all income and principal of the trust. She was also the surviving spouse of the deceased IRA owner.
In this case, the widow was the sole person for whose benefit the IRA is maintained. That let her take a distribution from the inherited IRA and roll it over to an IRA in her own name without having to include any of the distribution in gross income, provided the rollover was accomplished within 60 days of the distribution. In the past, the IRS permitted a similar result when an IRA was payable to an estate and the surviving spouse was the sole primary beneficiary of the estate. In each case, the surviving spouse effectively was the sole individual for whose benefit the IRA was maintained and intended.
While things worked out for the widow above, you still might not want to name a living trust or your estate as the beneficiary of your IRA because she had to apply to the IRS for a private ruling to be sure of the tax results, which is an expensive and time-consuming process.
Moreover, the widow couldn't have the IRA custodian transfer the inherited IRA directly to an IRA in her name because the IRA custodian was unwilling to transfer the inherited IRA to any IRA other than one with the exact same legal title. Therefore, she had to take a distribution, which raises the chance, if for some reason she's unable to roll over that amount to an IRA in her name within 60 days, the whole amount would be taxable.
Reference: Forbes (Dec. 23, 2020) “Should A Living Trust Be Beneficiary Of Your IRA?”