Retirement Planning
Most of us have some form of retirement savings. It is one of the best ways to allow investments to grow tax deferred.
Retirement assets do NOT pass by a will or trust. Instead, each IRA/401K has a Beneficiary Designation Form. This form is 100% responsible for controlling the distribution of your retirement accounts.
Many people fill out the Beneficiary Designation Form in their financial advisor’s office. Then they promptly forget about it!
Generally, a revocable trust should not be named as the beneficiary. That is because the beneficiary form already avoids probate. If your heirs are responsible “normal” adults who do not need any protection, simply naming individuals as primary and contingent beneficiaries may do the trick.
A primary reason why people name a revocable trust as a beneficiary is because the children-beneficiaries have spending issues, get divorced, or have substance abuse problems. Believe it or not, this is a fairly common scenario. But it is a mistake to use a revocable trust to protect IRA distributions, for the reasons noted below.
Spouses can rollover an IRA and name new beneficiaries. However, non-spouse beneficiaries, such as children, are not allowed to “rollover” an Inherited IRA. Instead, the Inherited IRA stays in the name of the deceased owner (Joe Schmo, deceased IRA, fbo Laura Schmo, beneficiary). Beginning January 1, 2020, the Secure Act requires most beneficiaries who are not “eligible Designations Beneficiaries or EDBS” to fully distribute an Inherited IRA by the end of the 10th year after the IRA owner’s death. There are no more annual required distributions. Any amount can be distributed or not, so long as the 10 year Rule is met.
Please see the Secure Act: Disaster & Recovery Strategies and Disaster Avoidance for Secure Act Rules in the legal library.
If your beneficiary may need creditor protection, or you prefer that a trustee control the distributions, you may create an Accumulation IRA Trust to hold distributions as outlined below.
IRA Trusts
Generally, a revocable trust should not be named as the beneficiary. That is because the beneficiary form already avoids probate. If your heirs are responsible “normal” adults who do not need any protection, simply naming individuals as primary and contingent beneficiaries may do the trick.
A primary reason why people name a revocable trust as a beneficiary is because the children-beneficiaries have spending issues, get divorced, or have substance abuse problems. Believe it or not, this is a fairly common scenario. But it is a mistake to use a revocable trust to protect IRA distributions, for the reasons noted below.
Spouses can rollover an IRA and name new beneficiaries. However, non-spouse beneficiaries, such as children, are not allowed to “rollover” an Inherited IRA. Instead, the Inherited IRA stays in the name of the deceased owner (Joe Schmo, deceased IRA, fbo Laura Schmo, beneficiary). Beginning by December 31st in the year after the IRA owner’s death, each beneficiary must take annual required minimum distributions out over his or her life expectancy as calculated on the IRS Single Life Expectancy Table. The child beneficiary can take out more than the required minimum distribution, but then pays greater income tax.
The best game is to distribute the smallest amount possible to allow the remaining IRA principal to continue to grow tax deferred. This is known as a “stretch IRA”.
Almost all revocable trusts automatically include language that will potentially ruin the opportunity to stretch-out the distributions. For example, a standard clause allowing the trustee to pay “estate taxes if necessary” from the trust will result in NO AGE for the stretch-out, because the “estate” has no age. The same thing happens if a charity is named as a beneficiary, since a charity has no age. Finally, if a trust has multiple beneficiaries, all of the beneficiaries will have to use the oldest one’s life expectancy for their annual minimum distributions. That could be a terrible result for younger beneficiaries.
If you have younger beneficiaries or are worried that your children may spend their share of your IRA right away, we have customized special Inherited IRA trusts, known as IBRAT™ (IRA Beneficiary Restricted Access Trust). Instead of naming a child or grandchild individually as the beneficiary of an IRA, consider naming a trust drafted ONLY to handle distributions of the IRA to that beneficiary. This will ensure the maximum stretch-out of distributions.
Types of IRA Trusts
There are two types of Inherited IRA trusts:
- Conduit IRA Trust. The trustee must pass out at least the annual required distributions of the beneficiary, but only the trustee can decide if additional distributions are advisable. This protects the principal of the Inherited IRA from creditors and spendthrift beneficiaries. In this type of IRA trust, the “last resort” beneficiary if the main beneficiary dies before his share of the IRA is distributed, can be any age or even a charity.
- Accumulation IRA Trust. This allows the trustee to hold the distributions in a continuing trust for the beneficiary and distribute them according to the tax laws in place. Currently, the Secure Act requires distributions in full to most beneficiaries by the end of the 10th year after the IRA owner’s death. Obviously, income tax must be paid on the annual distributions, but they are protected from the beneficiary’s creditors or divorce. Accumulation trusts can also be drafted to allow the trustee to hold the annual distributions under “special needs” trust terms. This protects a disabled beneficiary from losing aid or losing distributions to government entities. This type of trust is created only to control IRA distributions. It is very different from a “regular” trust.