Legal Briefs: Will my IRA affect my estate plan?

Most of the time, the answer is simple: it won't. Even if you set up a trust, you will continue to individually own your IRA and list individual beneficiaries for it. You cannot make your trust the owner of your IRA, and naming your trust the beneficiary of your IRA accounts can be very complicated. However, your IRA can be an important part of your estate plan, so it is important to understand what options are available and what you can do to provide the maximum benefit to you and your loved ones and other heirs.

If you do want your trust to be the beneficiary of an IRA, it is important that the trust qualify for the “look-through” rule. This rule says that the IRS must be able to determine whether there is a designated beneficiary and who that beneficiary is. The four requirements that the trust must satisfy are as follows:

  1. Validity. The trust must be valid under state law — or it would be but for the fact that there is no corpus (principal);
  2. Irrevocability. The trust must be irrevocable or will, by its terms, become irrevocable upon the death of the account owner;
  3. Identification. The beneficiaries of the trust who are beneficiaries with respect to the trust’s interest in the account owner’s benefit must be “identifiable from the trust instrument”; and
  4. Documentation. The plan administrator must be provided with certain documentation: (i) a copy of the trust and amendments (if any), or (ii) a list of all trust beneficiaries, including other details about contingent and remaindermen beneficiaries, as well as giving the plan administrator a copy of the trust instrument upon demand.

If the trust satisfies these requirements, the trust qualifies, and Required Minimum Distributions (“RMDs”) will be determined based on the life expectancy of the trust beneficiary. If there are multiple beneficiaries, RMDs are determined by the life expectancy of the oldest beneficiary. If the trust doesn’t qualify, then the “no designated beneficiary” rule will apply, and RMDs will not be computed according to any beneficiary’s life expectancy — thus, RMDs will be accelerated over a short time period.

There are some good reasons to leave IRA money to a trust after your death. Typically, it is to benefit someone who can’t be trusted to manage their money: a minor child, a spendthrift, or the spouse of a second or later marriage. In the last instance, a trust can be set up for those who want to leave enough money to care for their spouse and then direct any remaining funds to go to their children after the spouse passes.

Rules for inherited IRAs are different for spouses and non-spouse beneficiaries. As a spouse who inherits an IRA, you can either "rollover" the funds to your own IRA or wait to take RMDs until your deceased spouse would have been 70½. If you have other income, you may want to wait to take RMDs so your tax bill is lower.

The IRS has stricter rules for non-spouse beneficiaries of an IRA. These beneficiaries have three options:

  1. Cash in the IRA. This means emptying the entire inherited IRA and paying taxes on that sum at one time. If you really need the money that may be your best bet. However, be prepared for a huge tax bill!
  2. Take only RMDs. The IRS requires non-spouse beneficiaries of IRAs owned by people over age 70½ to start taking RMDs within a year of inheriting the IRA. Those RMDs are based on the beneficiaries’ life expectancy, not the life expectancy of the now-deceased owner of the account. Therefore, the younger you are the lower your RMDs.
  3. Cash in and empty the account over five years. You don’t have to stick to the RMDs or take all the money from the IRA at once. You can wait and take any sum you want, but once you start taking distributions beyond your RMDs you have to finish emptying the account within five years.

Option 2, often called a “stretch IRA,” takes advantage of the fact that younger beneficiaries have smaller RMD requirements. Individuals who know that their spouses have enough money to live on can extend the benefits from their IRAs by naming children, grandchildren, and even great-grandchildren as IRA beneficiaries. Those younger relatives then take RMDs that are small enough to trigger minimal taxes. The rest of the inherited account (the part remaining in the IRA) can continue to grow tax-deferred and increase in value. However, not all IRAs can be stretched, so consult your IRA provider and/or financial advisor if you are considering this strategy.

If you are not comfortable bypassing your spouse as your IRA beneficiary, you can instruct him or her to stretch it for you. With this strategy, you name your spouse as your IRA beneficiary. He or she then rolls your IRA into an inherited IRA in his or her name and starts taking RMDs at age 70½. Your spouse then names a younger relative as the beneficiary of that IRA. When your spouse dies, the young beneficiary starts taking the small RMDs described above. However, due to pending legislation, this last option may soon no longer be available.

To determine how IRAs fit into your estate plan, contact the experienced Oklahoma City estate planning attorneys at Postic & Bates today for a free, no-obligation consultation.

[As with all our posts, the contents of this article do not constitute legal advice and are subject to our site-wide disclaimer.]