Taxation & Estate Planning

Naming Your Trust as Beneficiary of Your IRA/401k, etc.

By Michael D. Bonasera, Esq.

In a post today called “Leaving IRA Money to a Minor”, David Goldman of The Florida Estate Planning Lawyer Blog (which is chock-full of good and sensible advice), links to this article at Fox Business about leaving your IRA to a trust and the benefits of doing so.

The article focuses on the benefits of reviewing your beneficiary designations and on naming your trust as the beneficiary as a probate avoidance tool.

And I agree with the article as to probate avoidance and on the article?s guidance regarding not naming minor children as beneficiaries. However, I think some caution is required here with regards to the potentially large amount of tax-deferred growth one can miss out on when naming one?s trust as the beneficiary of their IRA (or 401k and some employer retirement plans).

The Problem Of Minimum Required Distributions.

If you name a single trust as the beneficiary of your IRA, the minimum required distributions will be calculated using the eldest beneficiary as the measuring life. This is so even if the trust divides after your death into multiple sub-trusts… If that eldest beneficiary is your spouse, your children (and certainly your grandchildren) miss out on the benefit of that money growing tax-free over time. A trust for each child solves the problem, but that can be expensive given legal fees. Also, not just any trust will work. For example, a trust that doesn’t pay out to the beneficiary until age 35 usually won’t qualify, nor will one where payouts are at the trustee’s discretion or based on prerequisites, like going to college, working a required number of hours per week or staying out of jail.

It is possible to Stretch the benefits of one?s IRA over successive generations without binding them to your life expectancy, but careful planning is required.

How To Stretch Your IRA:

The surviving spouse (statistically it?s the wife) was named as the beneficiary (not a trust). The IRS allows her to roll it over into her own account. She is then free to name her own beneficiary or beneficiaries. At this point, the IRS will recalculate the required minimum distributions based on the joint life expectancy of the surviving spouse (wife) and the new beneficiary (usually a child).

When the surviving spouse (wife) dies, the account can continue to be paid out over the life expectancy of the beneficiary (child), rather than the wife or the decedent who was the original owner. This is nice because of the continued tax deferred growth of the assets left in the account ? good news. That child beneficiary has some choice regarding how to take distributions, but let’s assume that the beneficiary doesn’t need all of the money right away and wants to take the IRA payout over the longest period of time possible, thus reducing the tax burden.

As an Example:
Our surviving spouse, age 70, designates her child, 45, as her primary beneficiary and elects to take the minimum required distribution over their joint lives. Therefore, she takes the distributions over 26.2 years (based on year 2000 life expectancy tables). However, she dies at age 80. Her child will then continue to take the distributions but over his life expectancy at time of election (age 45, which is 37.7), less the elapsed 10 years, equaling 27.7. That child can name a contingent beneficiary. When the child dies, the contingent beneficiary in effect can continue to take distributions over the child’s remaining life expectancy (as if the child hadn’t died).

So, what does this all mean? It means that, with proper planning and with the agreement of the IRA custodian, an IRA payout can be stretched over a number of generations.

The benefits explained above are not available though if your trust was named as the beneficiary of your IRA, 401k or other qualified retirement plan.

If you?re concerned about how to deal with your qualified retirement assets at death or you?re not sure if your current plan was done correctly, do not hesitate to contact your local estate planning attorney.

Full post as published by The Ohio Trust & Estate Blog on January 13, 2008 (boomark / email).