A traditional IRA is what is considered a "qualified" account. In essence, this means that the account gets special tax treatment---in particular, allowing you to defer taxation until a later date. With these types of accounts, you do not have to withdraw the money all at once. Many advisors refer to this as allowing you to "stretch" the distributions over time. Ultimately, this allows you to reduce income taxes which you must pay.
With traditional IRA accounts, owners will often name a beneficiary to receive the proceeds of the account at the time of the owner's death. In most instances, the beneficiary can roll the IRA over into an IRA in the beneficiary's name. This defers taxes for the beneficiary by allowing the funds to be withdrawn over time. When a beneficiary is a responsible adult, this is a good plan. The IRA can be rolled over into an inherited IRA and the beneficiary can withdraw the funds over time. In essence, a "stretch" is available to the beneficiary.
But what happens if the IRA beneficiary is a minor or a financially irresponsible adult? Many financial institutions which administer IRA accounts will not allow a roll-over to an IRA in the minor's name. Similarly, many financial institutions do not allow the owner of the IRA to require the beneficiary to take the distributions over time. A minor beneficiary may have to take the distribution all at once. An irresponsible adult beneficiary may choose to withdraw the funds all at once. either way, this can result in income tax having to be paid all at once and likely at a higher rate.
What is needed in this instance is a planning tool which allows the IRA distributions to be taken out over time and thereby not cause a big tax all at once. The answer is what some lawyers and tax planners call a "see-through trust" (or sometimes, a "look-through trust").
In essence, these types of trusts are set up with special provisions to allow the trust to be named as beneficiary of the IRA. The trust allows the funds from the IRA to be taken out of the IRA according to the beneficiary's required minimum distribution (RMD) schedule rather than all at once. In doing so, payment of taxes is deferred and "stretched out" over time. The stretch can also mean that the taxpayer will ultimately be paying taxes at a time when he or she is in a lower tax bracket. All of this can reduce the tax burden.
In order to qualify as a see-through trust, the trust must meet the following requirements:
1. The trust must be valid under applicable state law.
2. The trust must be irrevocable.
3. The beneficiaries must be readily identifiable.
4. A copy of the Trust documentation must be provided to the IRA custodian by October 31st of the year following the year of the IRA owner's death.
Setting up a see-through trust is complex and should be done by an experienced estate planning attorney. As with most estate planning, establishing a see-through trust is not something that the "do-it-yourselfer" should undertake on their own!