Tuesday, November 20, 2012

The Benefits of an IRA Trust

As we have discussed in previous posts, there are many forms of trusts used in the estate planning process. A special type of trust, known as an “IRA Trust,” is a stand-alone trust, separate from a Living Trust that acts as the beneficiary of IRAs or retirement benefits. The provisions of an IRA Trust satisfy all of the regulations related to the distribution of IRAs and retirement benefits, allowing the beneficiaries to take advantage of their inherited benefits over their lifetime.
While there is nothing barring a Living Trust from being the beneficiary of an IRA, due to the regulations that govern the distribution of retirement benefits it may be difficult if not impossible to take advantage of the most beneficial distribution rules or provide for a lifetime distribution of benefits using only a standard Living Trust. For example, if the Living Trust beneficiaries include charities the Living Trust will not qualify as an "individual beneficiary" and thus the non-charitable beneficiaries will not benefit from the ability to “stretch out” the IRA benefits. In addition, if the Living Trust benefits elderly relatives, the shorter life expectancy of those relatives limits the ability to stretch out distributions and delay or defer income taxation for younger beneficiaries because the regulations base MRD on the life expectancy of the oldest beneficiary. The provisions of an IRA Trust avoid these problems and ensure that the IRA Trust’s beneficiaries enjoy the greatest benefit from their inherited asset.
The beneficiaries of the IRA Trust can be the same as those of the client's Living Trust. However, the distribution terms of an IRA Trust terms are often different from the Living Trust and frequently more restrictive in order to ensure that no matter what happens to the Living Trust assets, the IRA Trust assets will be available to help support children, grandchildren and other beneficiaries. Alternately, an IRA Trust can divide assets between different groups of beneficiaries. For example, the Living Trust may benefit a second spouse while the IRA Trust has children and grandchildren as beneficiaries. Finally, an IRA Trust can help beneficiaries in more difficult or complex situations, such as beneficiaries who are:

  1. Spendthrifts and unable to handle money
  2. Children with addictions
  3. Children with creditor issues
  4. Children with bad marriages
  5. Special care needs children, including those who qualify for government benefits
  6. A surviving spouse who is  unable to say no when children ask for money

In these situations, the IRA Trust Trustee can provide professional management of Trust assets, allowing the IRA assets to grow tax deferred, except for required distributions, and ensure that the beneficiaries do not waste those distributions.
If there are multiple beneficiaries, IRA Trusts are drafted and coordinated with the beneficiary designation of the IRA to allow each of the beneficiaries to use their own life expectancy in determining the minimum required distributions. For example, the beneficiary designation after the death of the client should read as follows: “50% to the sub trust for the benefit of Jane Doe under the John Doe IRA Trust.” With proper drafting, an IRA trust can provide not only for children, but grandchildren and beyond, allowing multiple generations to take advantage of the IRA benefits. In those circumstances, the IRA Trust is often known as a "Dynasty Trust" because it can provide for multiple generations.
Just like a Living Trust, the distribution provisions of an IRA Trust dictate how the beneficiaries receive distributions. One design option for an IRA Trust is the "conduit trust", under which the trustee has no power to accumulate plan distributions in the trust and must allocate any distribution received from the IRA or retirement plan to the beneficiaries. The conduit trust lessens the trustee’s ability to control the income but still allows control over principal distributions as necessary.
Alternatively, when it is desirable or necessary to impose greater control upon the dispersal of the RMD, an "accumulation trust" allows the trustee to hold the RMD in trust for the beneficiary’s benefit. For example, if the beneficiary of the IRA Trust is special needs child, it is important to limit income distributions in order to avoid adversely affecting the beneficiary's right to receive state or federal benefits. It is important to remember however when using an accumulation trust that the federal government taxes income received from the IRA but not distributed to beneficiaries according to the potentially higher trust income tax rates.
Whether a client wants to provide for multiple generations, ensure a lifetime of income for a beneficiary in a difficult personal or financial situation, or simply ensure that different groups of beneficiaries receive the asset that provides them the greatest value, an IRA trust is an extremely useful tool for a wide variety of situations. Due to the complexities surrounding IRA and retirement plan distributions, it is important to work with experienced estate planning attorney familiar with those regulations in order for an IRA Trust to achieve a client's goals.

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