You Don’t Have To Be A Millionaire To Leave A Legacy

An IRA Inheritance Trust Allows You To Leave a
Legacy For Future Generations

IRS regulations require that the owner of a Traditional IRA begin withdrawals at age 70-1/2. These withdrawals are referred to as “Required Minimum Distributions” (RMDs) which are considered income to the recipient and are therefore taxable. The Required Minimum Distributions (RMDs) are calculated based on the life expectancy of the owner using life expectancy tables. But what happens to the IRA after the owner’s death?

Back in 2003 the IRS issued regulations that permit a non-spouse beneficiary to “stretch-out” the taxable Required Minimum Distributions over his or her own life expectancy. However, in order to take advantage of this regulation, the non-spouse beneficiary cannot take the money out of the IRA or transfer the amount to his own IRA. If he does so the entire proceeds of the IRA are taxable in the year the proceeds were taken out or transferred and the ability to stretch out the taxable Required Minimum Distribution is lost.

This ability to compound the IRA investments, tax free, over a much longer period of time makes an IRA now one of the most valuable assets when passing wealth down from generation to generation. A $200,000 IRA inherited by a 50-year-old could be worth $1.5 million or more over his and his children’s lifetimes.

Although the income tax stretch-out can be obtained by naming individuals as beneficiaries on the IRA account, this choice can create a host of problems:

  1. Most IRA custodians do not advise the beneficiaries of the tax consequences of taking the proceeds from the IRA account and transferring them to their own. Only the decedent’s spouse can rollover the IRA without any taxable event.
  2. The individual beneficiary may at any time decide to take out more than the Required Minimum Distributions (RMDs) because he is not aware of the tax rules and the choices he has, or he gets bad advice or he simply wants to spend the money (or his spouse or another party influences him to spend it). As a result, taxation occurs much earlier, losing years of tax free compounding and essentially blowing the benefits of the stretch-out.
  3. The original account owner does not control who will eventually inherit the IRA assets after the primary beneficiary passes away.
  4. In June, 2014 the U.S. Supreme Court in Clark v. Rameker held that IRA retirements funds inherited by someone other than the spouse of the deceased are not exempt from creditors’ claims. If the beneficiary has a judgment against him or is going through a divorce (the spouse would have a claim on the proceeds) then the entire proceeds of the IRA could be lost.
  5. The IRA beneficiary may have poor money management skills, be a spendthrift, have a substance abuse problem or is too young or disabled to manage money.
  6. If the IRA beneficiary is receiving government benefits such as SSI or Medicaid he could lose them due to asset and income limitations.

A simple living trust or an accumulation trust typically cannot meet the requirements of obtaining the maximum stretch-out over the lifetime of the individual beneficiaries of the trust. In calculating the Required Minimum Distribution (RMD) in a simple living trust or accumulation trust the IRS uses the life expectancy of the trust’s oldest beneficiary. In addition, most simple living trusts or accumulation trusts do not have sufficient protections to thwart creditor’s claims.

In order to avoid these problems an IRA Inheritance Trust, also known as a designated beneficiary trust, creates a separate trust within the trust itself for each IRA beneficiary The IRA Inheritance Trust is drafted so that the maximum income tax stretch-out for each beneficiary is attained. In addition the IRA Inheritance Trust also provides protection against all of the six problems outlined above. It allows the owner of the IRA to leave a legacy to those beneficiaries he selects and to only those beneficiaries. If a beneficiary needs help with the payment of medical bills, college expenses, or other unforeseen expenses, the trustee is given discretion to withdraw some or all of the proceeds from the separate trust created for the beneficiary within the IRA Inheritance Trust.

If you have a 401(k) or other company retirement plan, you should consider and discuss with your tax and legal counsel the benefit of rolling that money over into IRA accounts in order to allow your non-spouse beneficiaries to take maximum advantage of the income-tax stretch and asset protection of the IRA Inheritance Trust.
The IRS strictly adheres to established regulations when they review and/or audit one’s estate. Therefore, expertise and great care must be exercised when planning for an asset that will be heavily relied upon by your family for future financial needs.

This Memorandum is based on current law and is for informational purposes only. It is important that you discuss all legal options and consequences with an attorney experienced in these types of trust. Should you wish to discuss your situation with Patricia L. Ferrari, an attorney with over 25 years of experience, please call her office at 813-597-8348.