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How an IRA Trust can Protect Your IRA Beneficiaries

08/15/2016

IRA Beneficiaries

For couples who find themselves in the enviable position of not needing all of their retirement savings, it is wonderful to consider making your children or grandchildren beneficiaries of an IRA account. There are certain risks to doing so, but there are also ways to do this that will allow you to put certain safeguards into place.

The Charlotte News-Observer’s article, “To ‘rule from the grave,’ establish an IRA trust,” suggests that you speak with a qualified estate planning attorney and explore the benefits of establishing an IRA standalone trust—which is also known as an "IRA trust,” an “IRA stretch trust” or an “IRA protection trust.”

This type of trust is approved by the IRS and may be more advantageous than designating individual children or grandchildren—or naming revocable living trusts as beneficiaries of IRAs. If you name your revocable living trust as a beneficiary, you must be certain 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 (RMDs).

Remember that if you go ahead and designate individuals as beneficiaries, you may create some headaches for them—including requiring a guardian to request permission from the courts to make distributions if the beneficiary is a minor. Also, the beneficiary may take higher distributions than necessary—often leading to increased taxation, eliminating the value of tax-free compounding and possibly running out of money. If the beneficiary is disabled, there is a risk of potentially losing needs-based government benefits. Other potential issues include the loss of control as to who will ultimately inherit the IRA after the death of the primary beneficiary and—if the beneficiary is not the spouse—the IRA being fair game for creditors.

Typically, a surviving spouse beneficiary can make the IRA his or her own and take RMD based on his or her life expectancy. The RMD doesn’t need to begin until the spouse reaches age 70 ½ or April 1 of the following year. An IRA inherited by a spouse and converted to his or her own IRA will still be protected from creditors from personal injury lawsuits, bankruptcy and the like. Distributions from an IRA inherited by a non-spouse are required to commence the year after the death of the IRA owner. The RMD is based on the beneficiary’s life expectancy.

A non-spouse inherited IRA isn’t protected in bankruptcy and may be hit with the claims of the beneficiary’s creditors. But the assets in a standalone IRA trust are protected by trust law, and they’re also protected from creditors. The trust can also control distributions so that they’re limited to the RMD based on the beneficiary’s life expectancy. That will defer the payment of income tax within the IRA, providing the greatest “stretch-out” of benefits to the beneficiary.

Speak with your estate planning attorney to explore whether or not the trust should be a conduit or an accumulation trust. The RMDs have to be distributed to the beneficiary in a conduit trust, but with an accumulation trust, RMDs may be accumulated in the trust. The accumulation trust is better if you have concerns about beneficiaries who are not responsible with money or have had issues in the past that may repeat: drug or alcohol addiction, bad marriages, risky behavior, etc.

These are complex legal documents that need to be carefully thought out to help you achieve your goals based on your individual circumstances. An experienced estate planning attorney will be able to help you determine which IRA trust is best for you and your family.

Reference: Charlotte News-Observer (July 30, 2016) “To ‘rule from the grave,’ establish an IRA trust”

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