Thursday, January 31, 2013

Other IRA Issues with Estate Planning


On Tuesday, I discussed funding retirement benefits to a Living Trust and some of the issues that may come about because of the funding. In response to that post I received a few comments and questions on related issues and thought it a good idea to expand on the topic in today's post.
The first comment talked about the opportunity of using a direct IRA beneficiary trust as well, to mandate a "stretch-out" of distributions and protect non-spouse beneficiaries from creditor claims. We discussed the IRA Trust in our post on November 20, 2012, but it is worthwhile discussing it again.  
The “IRA Trust”, is a stand-alone trust, separate from a Living Trust that acts as the beneficiary of IRAs or retirement other 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. Using the IRA Trust allows the client to design a special trust specifically for the IRA assets and perhaps even for different beneficiaries then for the majority of the estate under the client's Living Trust. Except for the required minimum distributions (RMDs), the IRA assets can continue to grow tax-deferred and protect beneficiaries against their own bad habits of this spending in mismanagement of money. Additionally, if an IRA trust provides for more than one beneficiary, if the IRA beneficiary designation form specifies the percentage of the account that will go to a specific sub trust for each of the beneficiaries, each beneficiary can then use their own life expectancy in calculating the RMDs for a particular year.
     A second comment asked how one meets the "see-through" trust requirements when one of the trust beneficiaries is a charity or other non-individual beneficiary. When a client names non-individual trust beneficiaries, those beneficiaries can be "removed" as a beneficiary for the purposes of determining the “see through” status of the trust. To “remove” the non-individual beneficiary the trustee must either make a distribution of the amount allocated to that beneficiary or arrange for the beneficiary to disclaim their interest. The deadline for this “removal” is September 30 of the calendar year following the calendar year of the account owner's death (the "Beneficiary Finalization Date"). If this is accomplished, the regulations exempt the non-individual trust beneficiaries for purposes of determining individual beneficiaries.
One might ask why anyone would disclaim his or her interest in a Living Trust. In some cases an older beneficiary will disclaim their interest in the IRA assets of the trust, because it will allow the younger beneficiaries (perhaps grandchildren in their 20s) to extend the IRA distributions over the lifetime of the oldest life expectancy of that group. This is important because unless you eliminate the elder beneficiary, all of the beneficiaries must use the oldest beneficiary's life expectancy in calculating the RMDs. Alternatively, a charitable beneficiary may disclaim an interest in IRA assets in exchange for a larger immediate gift that it can invest or put to use immediately.
On a final note, if there are sufficient assets in addition to the IRA to protect loved ones, and the client is charitably inclined, client may want to consider designating one or more charities as the beneficiary of the IRA. This will satisfy their charitable inclinations will save significant income taxes because the IRA will not be subject to income tax when paid to the charity. This can save a large amount of tax, especially where the estate is taxable for estate tax purposes and then the IRA is taxed for income tax purposes as it is distributed to individual beneficiaries. Naming a charity as the IRA beneficiary excludes it from taxation for federal estate tax purposes and income tax purposes.
Again, it is important that a client discusses their desires with experience counsel prior to designating beneficiaries in order to protection of beneficiaries and minimize taxation of the account.

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