Your Trust As Your IRA Beneficiary

I am often questioned by financial advisors, banks and mutual fund companies if I meant to name a trust as primary beneficiary of retirement accounts. Yes, I meant to do that. When we prepare a trust-based estate plan, we also prepare the beneficiary designation forms for the retirement plans to ensure that they track with the instructions in the trust. Many employer-based plans and all IRAs allow beneficiaries after the death of the participant to “stretch out” or distribute the retirement benefit over the lifetime of the beneficiary.

In these cases, we name your trust as your primary beneficiary of these retirement accounts. If you are married, we name your spouse as your contingent beneficiary. But if you are single, we name the kids as your contingent beneficiaries. This gives us the most options after your death.

Even though the IRS issued final regulations regarding retirement account minimum distribution rules in 2002, there are still many misconceptions in the financial advisor community regarding the naming of a trust as the beneficiary of retirement accounts:

Misconception #1: Naming a trust will cause a payout over five years. The general rule is that when your trust is named as your retirement plan beneficiary, the distributions must be made within five years after your death if death occurs before your required beginning date which is generally age 70½. If your death occurs after your required beginning date, then distributions to your trust must be made over your life expectancy and not over your intended beneficiary’s life expectancy.

There is an exception to the general rule called a designated beneficiary test. If your trust contains terms that assure that it meets the requirements of the designated beneficiary test, it allows your trustee to ignore the trust and look through to find and use the life expectancy of one of your trust beneficiaries when making distributions. This is just as if your trust beneficiary had been named directly a beneficiary of your IRA. The stretch out IRA concept still remains available to your trust and your beneficiaries.

To meet the designated beneficiary test, the trust must a) be valid under state law, b) have individual beneficiaries, c) have identifiable beneficiaries, d) have a copy of the trust delivered to the plan administrator, and e) be irrevocable upon death. I make sure that trusts I draft are specifically designed to receive retirement plan distributions and meet the designated beneficiary test. Not every trust out there qualifies as a designated beneficiary.

Misconception #2: There are no benefits to placing retirement accounts into a trust. The reasons to name the trust include both death tax planning and providing personal protections. By keeping the deceased spouse’s retirement in trust and equalizing the estates between the two spouses, you and your spouse can double the amount that is passed down to future generations estate tax free. This can amount to an additional $5.0 million in 2011 and 2012, and an additional $1.0 million in 2013 and thereafter.

In addition, you can protect what you leave to your beneficiaries from their creditors, from their divorcing spouses and from Medicaid spend down. Most of our clients like to leave inheritances in trust for their beneficiaries for life in order to provide them with these potential protections which is possible without sacrificing long term income tax deferral.

Misconception #3: Naming your trust as the beneficiary will not allow us to rollover your IRA to your spouse. Although we do not name your spouse as a primary beneficiary of your retirement account, your spouse is generally named as contingent beneficiary after your trust. Often times there are no estate tax issues with respect to your marital estate and there are not great concerns about remarriage protection, creditor protection or other protections for your surviving spouse. In those instances, after your death, your trust will “disclaim” or give a legal no thank-you to your IRA and allow the IRA to go directly to your surviving spouse.

Through the use of this disclaimer, your surviving spouse can then roll it over into their own IRA. This is especially useful for young surviving spouses who are less than age 70½. If the surviving spouse is less than 70½ and rolls it over to their own IRA, distributions do not need to begin until their required beginning date at age 70½.

But if your spouse is going to roll it over anyway, why name your trust as your primary beneficiary? The main reason is that in most instances after a death, when the spouse is named as a primary beneficiary of a retirement account, the retirement account is already rolled over into the surviving spouse’s own IRA before they ever come in to see the attorney. When that is the case, then we have just lost all of the opportunity for the surviving spouse to disclaim or give a legal no thank-you to allow the IRA to be distributed to the trust. By naming the trust as the primary beneficiary, we almost always get a call from the financial advisor to discuss what is the best way of handling the retirement plan. This way, a discussion among all team members can be held and the most advantageous distribution pattern can then be chosen.

Misconception #4: The home office recommends, or we always name the spouse as a primary beneficiary. The only reason that the home office would recommend or that a financial advisor would always name the spouse as primary beneficiary is because they are not familiar with the required minimum distribution rules with regard to designated beneficiaries. As long as your trust is considered a designated beneficiary, then your beneficiaries can still get the same stretch out over their life expectancies just as if the beneficiaries were named directly.

If there is more than one individual beneficiary in the trust and the trust is named as a beneficiary, then you generally must use the life expectancy of the oldest beneficiary. However, if you named the separate trust for each of your individual beneficiaries as the beneficiary of your retirement account, then you could generally use the life expectancy of each beneficiary for each separate trust.

Misconception #5: You can not change the beneficiaries of an IRA after the death of the participant. Generally after your death, unless there is a disclaimer or a legal no thank-you by a beneficiary, there is no way to change the beneficiaries of your IRA. However, if you name your trust as your primary beneficiary and you give the power to change beneficiaries of the trust to someone, then the ultimate beneficiaries of that IRA can also be changed. The power to change the beneficiaries of your trust is called a power of appointment. This tool allows your surviving spouse or trustee to effectively amend your trust after your death to take into account post-death changes in circumstances that occur.

Before you name your trust as a beneficiary of your retirement account, have your trust reviewed by a knowledgeable legal specialist to ensure that it qualifies as a designated beneficiary. If you name your trust as a primary beneficiary and it does not qualify as a designated beneficiary, you will end up with the negative tax consequences of the five year pay out. With proper planning and proper drafting, you can maximize the protections and benefits to your family and minimize their overall tax burden.

By Matthew M. Wallace, CPA, JD

Published edited May 22, 2011 in The Times Herald newspaper, Port Huron, Michigan as: Beneficiary needn’t always be human

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