IRA Trusts

© 2009 By M. Lorin Castleman, Attorney. All rights reserved.

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SHOULD YOU NAME A TRUST AS THE BENEFICIARY OF YOUR IRA?

If you care about what happens to the funds in your IRA after you die, the answer is definitely “Yes,” so long as you do not use a standard revocable trust.

Naming a properly drafted special IRA Trust as a beneficiary is the only way to provide asset protection and control over the beneficiary’s use and disposition of the IRA assets after the owner-participant’s death, and it is also the only way to guarantee protection of the “income tax stretch” over the beneficiary’s life.

The Problems

If a special IRA Trust is not used, and an individual is simply named as a direct beneficiary of an IRA, the following “bad things” can occur:

• a substantial portion of the IRA assets may be attached by the beneficiary’s creditors, or by successful litigants holding a judgment against the beneficiary;
• the beneficiary may use the assets to support a lavish lifestyle;
• the beneficiary may use the assets to support a drug, alcohol, or gambling habit; the IRA assets may be divided in a divorce proceeding;
• the assets may be poorly managed by the beneficiary or invested unwisely;
• the IRA assets or distributions could disqualify or prevent a beneficiary from receiving government disability benefits;
• the beneficiary’s IRA assets are exposed to his or her bankruptcy claims;
• if a beneficiary fails to designate his or her own beneficiary, or designates his or her estate as the beneficiary, the assets may be subject to an expensive public probate when the beneficiary dies;
• the owner-participant cannot control who will eventually inherit the IRA assets upon the death of the primary beneficiary, and the IRA assets may end up in the hands of a person to whom the owner-participant would never have left anything;
• if a beneficiary withdraws a large amount from the IRA, substantial immediate income taxation results; and,
• if the beneficiary is subject to estate taxes at death, a substantial part of the IRA could be depleted by both estate taxes and income tax if IRA proceeds are used to pay the estate tax.

If an IRA trust is used, all of these problems can be avoided while, at the same time, achieving maximum tax deferral and asset protection.

Conduit and Accumulation IRA Trusts

What is the difference between a Conduit Trust IRA Trust and an Accumulation IRA Trust?

A “conduit trust” requires that the required minimum distributions be passed on to the trust beneficiary as they are received by the trust.

In an “accumulation trust,” even though the trust must receive the required minimum distributions, it does not have to pass them on to the beneficiary. It is up to the trustee of the IRA Trust to make that decision.

Which is better?

It depends.  Although a conduit trust can protect the IRA assets that have not been distributed, all distributions that are made to the beneficiary are subject to unwise spending, may be used to feed a habit, and can fall into the hands of his or her his creditors and predators.  Also, those distributions might prevent a disabled beneficiary from receiving governmental assistance.

An accumulation IRA Trust avoids those problems, because the trustee can keep the required minimum distributions in the trust, and out of the hands of the beneficiary or others when appropriate. This means that accumulation IRA Trusts are preferred when there is concern about any of the bullet point problems listed above, or when the greatest asset and spendthrift protection is desired.

If either case the beneficiary’s life expectancy is used for IRA “stretch” purposes provided that the trust is properly designed.

In choosing between the two, keep in mind that we are not talking about protecting the principal, but whether or not you have any concerns about the required minimum distributions flowing immediately into the hands of the beneficiary. Both the conduit trust and the accumulation trust can protect the principal.)

Stand-alone IRA Trusts vs. Special Revocable IRA Trusts

A normal living trust cannot meet all of the requirements that are necessary to protect the IRA.  Therefore, if separate Stand-alone IRA Trusts are not used, special IRA sub-trust provisions must be drafted into the revocable living trust document. When an accumulation trust is used, there are a number of additional requirements and provisions that must be met, and drafted into the revocable trust document, in order to qualify the revocable living trust for receipt of the IRA proceeds.

A better alternative to adding special IRA trust provisions to a revocable trust is to use a separate “Stand- alone IRA Trust” for each beneficiary, especially if it is an accumulation trust.

The benefits of a separate Stand-alone Accumulation IRA Trust for each beneficiary are:

• The entire estate administration process is significantly simplified.
• Trust and estate plan documents are simpler and less confusing.
• Creditor and predator protection is significantly enhanced.
• Using a Stand-alone IRA Trust eliminates the possibility of making mistakes in administering IRA sub-trusts that are contained in revocable living trusts. (Allocating IRA distributions to an incorrect sub-trust contained within a master trust can result in income tax and beneficiary entitlement disasters.)
• Maintaining designated beneficiary status is much easier.
• Although separate trusts require separate tax returns, the fiduciary accounting and investment issues are greatly simplified.
• The possibility of triggering immediate recognition of IRA income is avoided.
• The life expectancy of each beneficiary of each separate trust can be used for determining required minimum distributions.

Conclusions

• Use an IRA Trust if:
• you care how its assets are managed and used by your spouse or other beneficiary after your death;
• you care about who gets to use the balance after your spouse or other beneficiary dies;
• you want to protect your spouse or other beneficiaries from creditors or predators after your death;
• you do not want the assets to inadvertently pass through probate;
• you want to minimize estate and income taxes; or,
• a beneficiary has special needs.
• Do not name a revocable living trust as the beneficiary of an IRA or 401(k) unless it has special IRA Trust provisions.
• Use a separate Stand-alone IRA Accumulation Trust for the best protection and easiest administration.
• A properly drafted IRA Trust can be named as the beneficiary of 401(k) and 403(b) plans, SEP IRAs, Standard IRAs, and Roth IRAs.
• Be sure to consult with well qualified legal counsel before naming a trust as the beneficiary of your plan.

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