Q. I began and continued saving the maximum in my 401(k) ever since it was offered at work and my company provided a good match. I’m now several years into retirement and have rolled this to an IRA. My husband agrees that if I should predecease him he would not need all of this money since he has a very nice pension and Social Security. Right now he is the primary beneficiary and our children are listed as contingent. We are thinking about making the children and/or grandchildren the primary beneficiaries of my IRA, but we don’t want them to have the ability to take out more than the required distribution based on their life expectancy. My mother named all of her adult grandchildren as beneficiaries of her IRA which included our four children. Two of the four cashed their inherited IRA out as soon as they could even though we advised them against it. Then the following year those two came to us for help with the tax bite that caused them but that is another story. I have a living trust that has some bells and whistles allowing me to rule from the grave so I’m wondering if I can just modify this and then name the trust as my IRA beneficiary. Your thoughts are appreciated.
A. You should meet with an estate planning attorney and discuss the benefits of establishing an IRA standalone trust also referred to as an IRA trust, IRA stretch trust or IRA protection trust. This is a type of trust approved by the IRS and may be more appropriate than naming individuals or revocable living trusts as beneficiaries of IRAs. If you name your revocable living trust as a beneficiary you must make sure that it has the appropriate conduit-trust language and that the wording of the beneficiary designation is correct to take advantage of the stretch-out of the required minimum distributions. If you name individuals as beneficiaries you may create other problems such as: the need for a guardian to request permission from the courts to make distributions if the beneficiary is a minor; the beneficiary may take higher distributions than necessary creating greater taxation, eliminating the value of tax-free compounding and possibly running out of money; lost benefits if the beneficiary is disabled and receiving needs-based government benefits; loss of control as to who will ultimately inherit the IRA after the death of the primary beneficiary, and if the beneficiary is a non-spouse the IRA could be subjected to the claims of creditors.
In most cases a spouse beneficiary can make the IRA their own and take required minimum distributions (RMD) based on their life expectancy. The RMD doesn’t need to begin until the spouse reaches age 70 1/2 or April 1 of the following year. An IRA inherited by a spouse and converted to their own IRA continues to be protected from creditors’ attacks resulting from personal injury lawsuits, bankruptcy, etc. Distributions from an IRA inherited by a non-spouse must begin the year after the death of the IRA owner and the RMD is based on the beneficiary’s life expectancy. A non-spouse inherited IRA is not protected in bankruptcy under federal law and may be subject to the claims of the beneficiary’s creditors. Assets in a standalone IRA trust are protected by trust law and assets will be protected from creditors. The trust can also demand that distributions are limited to the RMD based on the beneficiary’s life expectancy, which will defer the payment of income tax within the IRA providing the greatest “stretch-out” of benefits to the beneficiary. Your attorney will discuss whether the trust should be a conduit or an accumulation trust. RMDs must be distributed to the beneficiary in a conduit trust. In an accumulation trust, RMDs may be accumulated in the trust. The accumulation trust is best if you need more protection for the beneficiary such as person in a bad marriage, a person in a high-risk profession, a person with addictions or a person with special needs. This is a complex issue and a good estate attorney can work with you to develop the appropriate plan of action based on your personal situation and goals.
Holly Nicholson is a certified financial planner in Raleigh. She cannot answer every question. Reach her at askholly.com or P.O. Box 97128, Raleigh, NC 27624