OCTOBER 18, 2010 VOLUME 17 NUMBER 32
Three weeks ago we wrote about how to leave an IRA (or other qualified retirement plan) to a special needs trust for your child who has a disability. Two weeks ago we wrote about whether you should (and how you would) name any trust as beneficiary of an IRA. At the risk of getting too technical for most readers, this week we are going to tread lightly where few have gone before: let us explain what happens after you have named a trust as beneficiary of your IRA, and what choices the trustee of your trust might face.
First we have to clarify a couple of often-misunderstood concepts. We will write here about IRAs, but the same rules will apply to pretty much any “qualified” retirement plan. That means 401(k), 403(b), Keogh, SIMPLE, SEP-IRA and other plans will follow the same rules. Different tax rules apply to Roth accounts, but some of the same distribution principles will apply. For convenience, though, we will keep talking about IRAs.
There are actually several stages of IRA we might discuss. Let’s distinguish among them:
- A regular IRA is “owned” by the contributor. There may be some community property rules in the state in which the contributor resides, or some marital rights attaching to the IRA in non-community property states, but for tax purposes the contributor “owns” the IRA.
- One choice your beneficiary may have after your death is to “roll over” your IRA. If your beneficiary is your spouse, he or she can roll the IRA over into a new IRA in their name. This, incidentally, is where the IRA/401(k) (and etc.) distinction gets muddy; your spouse can roll your 401(k) account over into a new IRA. Those IRAs, whatever their source, are usually referred to as “roll-over” IRAs.
- Spouses are not the only ones who can roll IRAs into a new account. Non-spouse beneficiaries can also do something similar, and the resulting accounts are often called “roll-over” IRAs, too. But they are different. They are also “inherited” IRAs (see below), and the beneficiary must begin withdrawing money from an inherited IRA immediately.
- If a non-spouse beneficiary leaves your IRA right where it is, they become the owner but the IRA is now an “inherited” IRA. They can designate a beneficiary in case they die before withdrawing all the IRA funds, but any beneficiary will have to make withdrawals at your beneficiary’s rate. So, in other words, you name your 45-year-old daughter as beneficiary, you die, she names her 22-year-old son as her beneficiary, and upon her death he has to withdraw based on her actuarial life expectancy, not his own. She might have decided to move your IRA to another custodian; in that case she has an IRA that is both a “roll-over” and an “inherited” IRA.
With that background, the Internal Revenue Service has recently clarified how this all can work if you name a trust as beneficiary of your IRA. In Private Letter Ruling 201038019, issued on September 24, 2010, the IRA gave guidance to an individual taxpayer who requested approval for a proposed way of handling just this problem.
Private Letter Rulings, by way of background, are not intended to be official regulations or rules. They are individual guidance offered (for a substantial fee) to individual taxpayers who want to be sure they are not going to get in trouble. Although “private” in the sense that they apply only to that taxpayer, they are public in the sense that the IRS discloses them to everyone, and they do give some indication of how the IRS thinks about the issues addressed. You are probably safe proceeding on the basis of an Private Letter Ruling.
Here’s what the taxpayer proposed to do, and what the IRS approved, in the recent Private Letter Ruling:
- The decedent had named his revocable living trust as beneficiary of two IRAs. He had three children, each of whom was to receive an equal share of the trust after his death.
- The trustees of his trust proposed to divide each of the IRAs into three separate IRAs. In other words, there would be a total of six IRAs, still (for the moment) in the name of the decedent. Then each child would be named as beneficiary of two of the IRAs — one from each of the original IRAs.
- Once that was accomplished, each of the six “transitional” (their term) IRAs would be rolled over into a new IRA. Each of those new IRAs would name one of the children as the inherited owner, and each child could then name his or her own IRA beneficiaries.
- The custodians of those “final” six IRAs were each given a copy of the decedent’s revocable living trust, which was valid under state law and became irrevocable upon the decedent’s death. Those elements of the plan critical because they are required by federal tax law.
- Each of the three children would be required to begin withdrawing their IRAs immediately, and at the rate calculated for the oldest of the three children.
The taxpayer’s proposed approach was fine with the IRS, but it would not necessarily be the only way to proceed. The trustee of the trust might be permitted, for instance, to leave the IRAs right where they were, to withdraw the funds over the period of the oldest child’s life expectancy, and to distribute those withdrawn amounts to the three children. But the IRS guidance makes it clear that this approach works, too.
The Private Letter Ruling doesn’t address one question. Why would the original IRA owner have named his trust as beneficiary if the IRAs were going to be distributed outright to the three children anyway? In such a case, we usually recommend that the owner name his children as beneficiaries directly — thereby avoiding the shortened payout period based on the oldest child’s life expectancy, as well as the need to go through the intermediate steps described in the Private Letter Ruling.
There are a number of reasons the IRA owner might have chosen to leave his IRAs to his trust. Usually those reasons include a disabled spouse, a child receiving public benefits, an unequal distribution of proceeds or some other complication. The Private Letter Ruling in this case does not give us enough information to determine which, if any, of those conditions applied. Still, it does give us valuable guidance for those cases in which a trust is named as beneficiary of an IRA.
30 Responses
Thanks, interesting and informative.
I am considering to leave IRA to trust to support my spouse if she survives me and then give it to my daughter.
I am not too concerned about distribution rate as long as MRD is not more than the support for my wife.
What are the tax consequences when an IRA is left to a Trust
and there are charities as beneficiaries rather than individuals?
Is the trust then subject to the high rates in effect at the time?
It’s hard to be certain (there is at least one variation in which this answer would not be correct), but it is likely that the principal effect would be to require that the IRA be withdrawn within five years of the owner/participant’s death. No “extra” tax, in a sense, but tax might have to be paid sooner and perhaps at a higher marginal rate.
Robert Fleming
Fleming & Curti, PLC
Tucson, Arizona
Sarwan,
There may be a better and more efficient way. Contact a planner, not a bank, insurance agent, or broker and ask them to explain any other more efficient options.
I have made the beneficiary of my IRA my revocable trust
Under the terms of my revocable trust I have named my daughter as IRA primary beneficicary, howerver the bank shall be guardian of these funds for her benefit because she is spendthrift. Do you think this will qualify as a valid rollover. Thank you
Mr. Sitter:
It is so hard to be sure based on incomplete information — and that is not intended to be an invitation to give us all the details here. Instead we strongly recommend that you meet with a qualified attorney in your locality. He or she will want to know your family circumstances, more specifics about your concern over your daughter’s inability to handle money, the size of your IRA and the rest of your estate, a copy of your existing trust and IRA beneficiary designation and probably some other items. Then he or she will have a conversation with you about the tradeoffs, your goals, the costs and whether you have already done everything exactly right.
Good luck. We do know that these things are more complicated than it seems like they ought to be. We have tried to simplify them somewhat in our newsletter articles (including this one), but these articles are not a good substitute for individualized back-and-forth interaction with a good lawyer.
Robert Fleming
Fleming & Curti, PLC
Tucson, Arizona
Is it possible to have inherited an IRA, then name a trust as the beneficiary of the inherited IRA and then have the benficiaries of the trust stretch the distributions individualy or as a look through using the oldest beneficiary?
Chuck:
If you inherit an IRA (and I assume here that you inherited it in your own name) the minimum distributions are set based on your age in the year you received it. You can name a beneficiary — including a trust — as recipient if you die, but the distributions continue to be calculated on the basis of your age.
Different answer if you inherit it from a spouse — then you can roll it over into a new IRA and use the same rules for distributions as those applying to your own IRA. That’s more complicated. But assuming that’s not what you were asking about, then upon inheritance it is generally too late to make changes in the payout speed.
Robert Fleming
Fleming & Curti, PLC
Tucson, Arizona
I have a Traditional IRA with my Revocable Living Trust (RLT) named as beneficiary. My wife and I are both 71 and I am taking Required Minimum Distributions from the IRA. Upon my death my wife becomes the trustee of my RLT. Part of the reason for setting up my RLT as beneficiary is to protect it from estate taxes. When I die will my wife as trustee of my RLT be able to continue to take Required Minimum Distributions based on her age for the remainder of her lifetime? Will the IRA then pass on to the “Childrens’ Trusts” that are provided for in my RLT, and will they then be able to continue to take Required Minimum Distributions from the IRA based on their ages?
Bill:
Your question has gotten too complicated to even take a stab at it. Please talk with your estate planning lawyer and your accountant; they should be able to fill you in on the required minimum distributions based on your situation.
If I had to hazard a guess I would say that it is likely that the structure you have set up will compel withdrawals at your wife’s minimum distribution rate even after her death. But that could be wrong, depending on the actual terms of your trust and after a review of your beneficiary designation. It is a high enough likelihood, however, that if “stretch-out” of your IRA (that is, allowing the smallest possible withdrawals over time) is critically important to you, you might want to rethink the arrangement.
Good luck figuring it out. This stuff sometimes gets more complicated than it ought to be.
Robert B. Fleming
Fleming & Curti, PLC
Tucson, Arizona
http://www.FlemingAndCurti.com
My father left his IRA to his Irrevocable Trust (used for owning/holding life insurance proceeds). He was 80, so already required to take RMDs. The beneficiaries of the Trust are me, my siblings and a niece and nephew. What are our options going to be? Can we take distributions over time or will we have to take our entire distribution at one time? If we can take out over time (5 year ‘stretch’ or longer?) whose age do we need to use to figure distributions?
Sandy:
It is impossible to answer your question without more information, and you will likely have a couple of options. You should consult an attorney in your community; choose one who is familiar with retirement planning issues. You might look to the American College of Trust and Estate Counsel (ACTEC) website for someone near you, or check the National Academy of Elder Law Attorneys (NAELA) site.
That said, there are a couple principles at work here, and they bear some mention:
1. You might be able to leave the trust in existence, and the IRA could then become an “inherited” IRA with the trust as the beneficiary. That would mean that the oldest beneficiary’s age would be used for the RMD (Required Minimum Distribution) calculations. Remember: that’s the oldest possible beneficiary — so if the trust says after all of the people of your generation dies, the trust goes to your uncle Dave, then it is Dave’s age which is used for the calculation.
2. You might be able to segregate the IRA into separate shares, provided that you do it before September of the year after your dad’s death. That might make it possible to use each individual’s age in calculating his or her distribution amounts.
3. Unless the trust names a charity or someone’s estate as beneficiary, or otherwise fails the “designated beneficiary” test (perhaps we will explain that in more detail in a future installment of our weekly newsletter), you probably will not be stuck with the five-year withdrawal option.
This is complicated stuff — unnecessarily so, in our view, but there it is — so get good professional advice about what to do next.
Robert B. Fleming
Fleming & Curti, PLC
Tucson, Arizona
I’M 94 AND HAVE MY LIVING TRUST THE BENEFICIARY OF MY ROTH IRA. UPON DEATH, CAN THE TRUSTEE CLOSE THE IRA AND DISTRIBUTE THE CASH, ALONG WITH OTHER CASH TO INHERITANTS? IN CLOSING THE IRA, IS THERE ANY TAX DUE
AND PAYABLE BY THE TRUSTEE ?
Short answer: yes, the trustee can, and no there should not be an income tax due. You might want to sit down with an attorney to review the trust and the beneficiary designation, and/or talk with your accountant. More or less daily we see people who tell us precisely how their trust and beneficiary designation are set up, and then turn out to be wrong — not because they are stupid but because there are so many moving parts and this stuff is so much more complicated than it really needs to be.
Robert Fleming
Fleming & Curti, PLC
Hi,
Mom passed Dec 2012 and left her Sep IRA to her trust (the trust is the named beneficiary), my brother and I are the executors of the trust. It seems like my brother and I are getting conflicting information everywhere, some from CPA’s. Most of the advice causes a full taxable event (cashing out to the trust) with a tax rate I am unaware of or a five year payout, again with no clarity of tax consequences. Our hope was to somehow split the Sep IRA into two equal parts and start MRA based on individual life expectancy or life expectancy of the oldest sibling. Additional information, Mom was 69 year old at her passing and had not been taking anything from the IRA (no withdraws). The only two people who will receive the Sep IRA are my brother and I. Please help us do this the smart way as we wish to be good custodians.
Regards,
Max
Max:
Talk to a lawyer who knows something about IRA accounts right away. Take a copy of the trust, a copy of a recent IRA statement, and a copy of the beneficiary designation form with you. We can’t tell you the answer without looking at the trust — the language of the trust will probably affect the answer. Also, be aware that not everything the IRS permits you to do is always permitted by the IRA custodian — but you should be able to move the IRA to a more cooperative institution if that is the problem.
Good luck. This stuff really is complicated — more complicated than it needs to be.
Robert Fleming
Fleming & Curti, PLC
Tucson, Arizona
I have a revocable living trust that serves as a long term trust with property control feature which allows me to provide for my brother during his lifetime. Then upon his death, my RLT will be distributed to a designated charity. I also have Roth IRA and IRA. Currently I have my brother as beneficiary. Can I change beneficiary to my RLT with the purpose that after my brother dies, the assets in my IRA and ROth IRA can also go to the charity? Or it does not matter since my brother will have to take withdrawal and has control over the assets in my IRA’s anyway?
Jane:
You may have a difficult choice between naming your brother as beneficiary and naming the trust. Because the trust has a charitable beneficiary, it may not qualify as a “designated beneficiary” on your IRA — that could result in it having to be withdrawn in the five years after your death. Talk to an experienced attorney. Bring along as much of the account information as you can lay your hands on. Show her or him your question — it’s a good one, but raises some additional questions for you. Best of luck.
Robert Fleming
Fleming & Curti, PLC
Tucson, Arizona
My father in law has an IRA. We are preparing a revocable trust for a portion of it for his burial with the funeral home. Is there a way to protect the rest of his funds in case he has to be in a nursing home? He does not have a lot but know the nursing facility will eventually take it.
Thank you for your time.
Ms. Huston:
Your question is very state-specific. Some states are much more relaxed than others about what kinds of planning options work, and a very few treat IRAs differently than other assets. Talk to an elder law attorney in your community. You might try looking at the National Academy of Elder Law Attorneys website for a local lead if you do not know an attorney in the field.
Good luck.
Robert Fleming
Fleming & Curti, PLC
Tucson, Arizona
Decedent named his trust, which became irrevocable at death, as the beneficiary of his IRA. The decedent had begun the RMDs prior to death. Assuming that trustee can divide the IRA, based on the PLR 201038019, can each beneficiary decide whether to take a lump sum or use the life expectancy of the oldest beneficiary?
Eric:
As I understand your question, it is not a tax question but a trust question. Does the trust divide into shares and then call for outright distribution to each beneficiary? If so, then each beneficiary should be in charge of his or her own share, and can decide to cash in his or her separate IRA (and pay the tax quickly) or not. Or does the trust continue for some or all of the beneficiaries? If so, then the trustee of each sub-trust will be in charge of the decision.
An interesting question (which you haven’t asked) could be raised about whether each separate share could use its own beneficiary’s life expectancy for minimum distributions. Possibly — depending on the terms of the trust.
One lesson from these simple facts: there is no such thing as simple facts.
Robert Fleming
Fleming & Curti, PLC
Tucson, Arizona
I am 55 years old, divorced, with 23 and 25 year old daughters. I would like to set up an estate plan that would ensure that the inherited funds would be spread out over the majority of my daughter’s lifetime. In other words, prevent the assets from being depleted quickly, like a future spouse talking them into withdrawing all the funds and buying a restaurant… A significant portion of the estate is in IRAs (not Roth). I was thinking a trust could be created with distribution rules, like capping the annual withdrawal to the remaining balance divided by (70 minus the oldest living daughter’s age). Can this kind of withdrawal controls be accomplished on inherited IRAs?
Randy:
Talk to an experienced estate planning attorney in your area. You should be able to accomplish something similar to your idea, though perhaps with a slightly different calculation method. If you don’t know who to contact, you might look for someone who has been selected as a Fellow of the American College of Trust and Estate Counsel — he or she is more likely to have experience with this kind of complex planning for retirement accounts.
Good luck.
Robert Fleming
Fleming & Curti, PLC
Tucson, Arizona
My will provides for the establishment of a trust for a disabled son after I die. I want the trust to be the beneficiary of my IRA. What is the proper wording to use naming the trust the beneficiary?
Jim:
Talk with your lawyer. There are too many variables to allow a safe, accurate and helpful answer to such a general question. But one thing: it might make things easier if your attorney drafts a stand-alone trust for your son, rather than one in your will. Don’t be surprised if you get that advice.
Good luck
Robert Fleming
Fleming & Curti, PLC
Tucson, Arizona
My aunt left IRA to Irrevocable Trust created when she passed, several beneficiaries and not all equal distributions. We decided to cash the IRA. Will the estate pay this tax or will we pay tax on the portion we each received?
It’s not clear from your inquiry whether the trust will have to file a tax return or not, but whether it does or not the beneficiaries will be liable for the income tax (at their own tax rates) on the income they ultimately received. It’s likely that the trust itself will pay no tax. Her estate will not be liable for any income tax unless some of the IRA income is imputed to the estate (which will probably not be the case, based on your limited presentation of facts).
This area is tricky, however. You should chat with an accountant about what to file and how to treat the income from the IRA, just to be sure.
Robert B. Fleming
Fleming & Curti, PLC
Tucson, Arizona
http://www.FlemingAndCurti.com
My 401k makes up about half my estate. My trust is the current beneficiary of the 401k. My trust beneficiaries are my children and a couple of charities. Is it possible to make sure that the charitable beneficiaries get paid from the 401k first and that my children get paid from my other assets first, in order to reduce income taxes?
Jon:
You have not given us enough information — and this is not an invitation to post more information on a public website. IF you live in Arizona you can certainly call to set up an appointment to discuss your 401(k) and your trust. Otherwise, you should meet with an experienced estate planning attorney in your community. Not sure how to find one? Look at the website of the American College of Trust and Estate Counsel (www.actec.org) or the National Academy of Elder Law Attorneys (www.naela.org) as two good leads.
Robert B. Fleming
Fleming & Curti, PLC
Tucson, Arizona