For many, a not so small part of their wealth is held in retirement accounts. When it comes to inheritance and estate planning, special considerations are necessary to ensure that these assets are protected and distributed according to the owner’s wishes.
Typically, retirement assets, such as IRAs, are passed via beneficiary designation. For example, for a married couple with children, it would be common to designate the spouse as primary beneficiary and children as secondary. In certain scenarios, however, it is advantageous to name a trust—rather than a particular individual—as the designated beneficiary. Once the retirement account becomes inherited by a non-spouse beneficiary (i.e. children), the IRS treats this inherited retirement account differently.
Specifically, once inherited, the beneficiary is obligated to begin taking required minimum distributions (RMD) from such funds within a more immediate time horizon of either five years or over the beneficiary’s life expectancy (known as the “stretch”). The goal in planning for inheriting retirement assets is to maximize the stretch so that the tax-deferred, long-term growth benefits of retirement accounts are maximized. Trusts can serve as an appropriate conduit to protect and preserve these assets.
Not all trusts are created equal, and naming a revocable family trust as the beneficiary of these accounts may have drawbacks, including a more fixed distribution schedule and the lack of creditor protection. Even worse, the IRS may not allow the stretch, resulting in the assets becoming immediately, taxable income.
Enter the standalone retirement trust (SRT). The SRT is a specific type of trust that, upon the death of the retirement account holder, is designed to allow retirement assets to grow tax-deferred, while also protecting the inheritance from future creditors of the beneficiary.
Thus, when considering an SRT, we keep three main goals in mind:
1) We want to “maximize the stretch” and allow for the tax deferral that retirement accounts provide. The primary benefit of these accounts is that they can grow tax-free. When these assets are transferred from to a beneficiary, special planning is needed to preserve this tax-deferred status. Otherwise, assets will be liable to taxes upon transfer and remove the primary growth benefit of such savings.
2) We want to provide creditor protection. Inherited assets are not shielded from creditor claims in bankruptcy proceedings. Rather, they may be treated as income and assets of the beneficiary, and thus, may be claimed by creditor. To protect such retirement assets from creditors, SRTs provide a wall of separation between trust assets and a beneficiary’s creditors.
3) We want to provide structure for how retirement funds may be used. Naming a beneficiary directly limits this structured distribution option, as the beneficiary will have full rights over and access to the funds, inheriting them as income. If one names a trust as beneficiary, the trust can contain stipulations concerning disbursements.
There is a current debate among estate planning attorneys as to whether a separate trust should always be created to receive and administer significant retirement plan assets. Though most attorneys think good estate planning can be done with only one master trust, there are various drafting, compliance and post-mortem administration problems that are minimized by segregating these assets and using a separate trust solely for retirement benefits.
A separate trust can be created in three ways: 1) as an inter-vivos standalone trust (often called a “standalone IRA trust”); or 2) as a subtrust of an inter-vivos revocable living trust that holds other assets as well Separate IRA trusts will have different taxpayer ID numbers than the master living trust or probate estate. Another issue is how to create beneficiary designations to work in conjunction with the drafting of the trust to hold retirement assets.
The most wonderful cutting-edge trust can be undermined by an improper or incomplete beneficiary designation form. This is a more complicated debate than many would like to admit. There can be substantial differences among documents and designations that will have a critical impact on the distribution and taxation of these funds.
A standalone trust has the following advantages:
1) A standalone IRA trust increases the likelihood that the estate plan for the IRAs will survive later planning by another attorney who does not understand or appreciate the complexities of estate planning with IRAs. Attorneys routinely revoke, restate or amend old trusts, but would take more care in doing so with a specially labeled, separately signed IRA trust. A standalone IRA trust might also make later amendments easier (especially explaining to clients) when tax law or retirement asset mix changes the dynamics of the planning. This is especially true where trusts are designed to potentially accumulate retirement plan distrtibutions (accumulation trusts), since the requirements of this planning are still evolving.
2) A standalone IRA trust increases the likelihood that the trustee will understand the complexities of administering separate trusts with IRAs and retirement plan assets, and ensuring that the IRA funds flow into the right trust. Living trusts often have an easily overlooked clause in the document to create a separate trust for IRA and retirement plan assets, and beneficiary designations will often fail to pay directly to this subtrust. Experienced estate planning attorneys and trust administrators may properly administer the creation of the subtrust, its separate EIN and any in-kind IRA transfers, but not everyone has the knowledge and experience necessary and this exposes the trust to mistakes. Even experienced attorneys, CPAs and financial advisors have difficulty with IRA providers making in-kind transfers. If improperly administered, the IRA may be paid to the master trust for the spouse or children rather than to the IRA subtrust, which could be a disaster if discovered too late. Every time a trustee-to trustee transfer or rollover is made, chances for major titling errors increase.
3) A standalone IRA trust might allow the Living Trust to be simpler and less confusing. This is especially true for the clients who insist on understanding every word and paragraph of the trust.
4) A standalone IRA trust, due to its specifically stated purpose and special treatment, would probably be easier to amend through a court proceeding after a grantor’s incapacity or death, should that be required. Further, the clear labeling and special treatment of a standalone IRA trust makes the grantor’s purpose, qualifying as a designated beneficiary, see-through trust, unambiguous. This flexibility is especially important for accumulation trusts, which may be subject in future years to revised interpretations.
There are numerous reasons to use a Stand Alone IRA Trust. At the same time there needs to be decisions made which can affect the structure and details of the trust. Each client has their unique needs and must be considered as such. Nevertheless, in all cases, advance planning will always work to one’s advantage, vs. leaving the outcome to chance.
