Estate planning is the preparing of legal documents to carry out your testamentary intent. Estate planning does not just take into account the high net worth individual who is primarily concerned about estate taxes, but rather planning for everyone’s testamentary intent. Testamentary intent is what you want to happen when you die. Notwithstanding, the general definition estate planning can include sophisticated gifting options to reduce one’s taxable estate and avoid or diminish federal and state estate taxes.
As the baby boomers get older, and we continue to hear the oft repeated saying,
We are about to experience the greatest transfer of wealth in history
One of my planners recently asked my opinion about a situation – his client, a concerned parent, is about to retire and has approximately $2,500,000 in qualified money (IRAs/401(k)s, etc) and wanted to know his planning options to protect this money in case he untimely dies, i.e. before it is exhausted.
Question Number 1 – Why Name a Trust a Beneficiary of an IRA?
Basic spend thrift protection! If your beneficiary doesn’t own the IRA, outright, then you have effectively put “controls” on the money even though you have died. How much control will be discussed later.
If you leave a beneficiary your IRA, outright, then there is nothing stopping that person from burying you and then cashing out the entire account. Most people aren’t aware that they do not have to stretch it over their lifetime, nor are most people aware if your estate is named as a beneficiary of your retirement account, a stretch is not possible!
Put more sufficiently, if the beneficiary can’t invade the retirement account without the Trustee’s Approval (Trustee = gatekeeper who you initially choose) then they can’t waste it!
Additionally, there are more advanced reasons of doing this facet of planning associated with bankruptcy law, but that is beyond the scope of this blog (there have been 6 cases in 6 different states that have invaded an inherited IRA!).
Question Number 2 – How do you Name a Beneficiary-Trust?
There are 2 main types:
1) Conduit (i.e. see through)
When the beneficiary is a conduit trust then the annual Required Minimum Distributions (RMDs) also known as Minimum Required Distributions (MRD) (I will do a whole post on RMDs) – that get paid to the trust are distributed right out to the trust beneficiaries and the trust beneficiaries pay tax at their personal income tax rates on the RMD amount. The benefit – Beneficiary can’t get to corpus without gatekeeper’s approval
2) Discretionary a/k/a Accumulation Trust
RMDs are paid to the trust from the inherited IRA then trustee decides whether the money will remain in the trust or be paid out to the trust beneficiaries. Any funds not paid out to the beneficiary are accumulated in the trust and that income is taxed at trust income tax rates (compressed). Beneficiary can’t get to income or corpus without gatekeeper’s approval.
Question Number 3 – What are the logistics to get this done?
First step is talking to an attorney and financial professional. You need this document drafted by a professional. Regardless of which one you choose the trust needs to ‘qualify’ to obtain stretch distributions:
- Trust must be valid under state law
- Trust but be irrevocable or become irrevocable at the death of the owner
- The beneficiaries must be identifiable
- Trustee must provide a copy of the trust or a list of the beneficiaries and their entitlements to the custodian or plan administrator by Oct 31 of the year after the owner’s death
- This factor is most often missed because the trustee is usually a layperson
Unwritten 5th element – Beneficiary must be an individual (or qualifying trust) or you will lose stretch, i.e. beneficiary can’t be an estate or corporation.
Second step is fixing your beneficiary designation
- Different IRA custodians will have different rules – Generally:
- “X Irrevocable Trust Dated Y”
- Z, as trustee for X Irrevocable Trust Dated Y
- Can even do it under Last Will and Testament – X Trust under Article V of Z’s Last Will and Testament etc.
- Different subtrusts – % or absolute Dollars
- Sub Trusts
As always you should check with Legal Counsel before attempting to implement this type of estate planning technique as it can be problematic if done incorrectly.