By Philip Levin, Esq.
Individual Retirement Accounts (IRAs) were not designed by Congress to be wealth transfer vehicles. They were created to serve as a supplementary source of income for wealth accumulation purposes.
Within the past few years, the IRS has issued final regulations with respect to the tax code section that created IRAs. These regulations govern the calculation of required minimum distributions (“RMDs”) from IRAs.
Why is this change in the law so important to you now? Because these regulations dramatically alter the way that you can plan for the distribution of your tax-deferred accounts to your IRA beneficiaries, from a tax, financial, and estate planning viewpoint.
The key aspect for you is that current law now permits a non-spouse beneficiary to “stretch out” the taxable required minimum distributions over his or her actuarial lifetime. As a result, the ability to compound IRA investments, income tax free, over a much longer period of time, now makes IRAs one of the most valuable assets when passing wealth from one generation to the next.
For example, a $200,000 IRA, owned by you, inherited by your 50-year old child, could be worth $1.5 million or more over the child and grandchild’s lifetime! In essence, securing maximum income tax deferral, through “stretch out” provisions authorized by the IRS, is now a prime planning objective for many affluent clients.
Similar to the distribution of property held outside of tax-qualified retirement plans, there are two ways to distribute property upon death, outright or in trust. This income tax “stretch out” available to you can be achieved either by naming individuals as outright beneficiaries or by naming a qualified trust as a beneficiary. However, naming individuals as beneficiaries of IRAs often create a host of unforeseen and unexpected problems, including:
- The individual may, at any time, decide to take out all funds or more than the required minimum distributions because he or she is not aware of the tax rules, receives bad advice, or simply that your beneficiary, spouse of the beneficiary, or another party influences your child to withdraw and spend the money. The result is that significant taxation will occur much earlier than necessary, losing years of income tax free compounding, which essentially destroys the benefits afforded through “stretch out” planning opportunities.
- You, as the original account owner, do NOT get to control who eventually inherits your IRA assets, after the primary beneficiary;
- The beneficiary may have poor investment management skills or select someone other than you to manage the entire IRA portfolio;
- The beneficiary may be a spendthrift, suffer from a disability, or just be too young to manage the money invested in your IRAs;
- In the event that one of your children gets divorced and is a beneficiary of your IRA, the IRA can easily be exposed to division, through a property settlement or judicial proceeding, a likely event, given that the divorce rate in the U.S. is about 50%;
- A beneficiary receiving government benefits could lose federal funding under special programs being utilized or state aid;
- Since we live in a very litigious society, a lawsuit filed against your beneficiary could subject the IRA assets to attachment; and
- The risk of all of the above problems and concerns for you and your family can be dealt with much better by establishing an IRA Trust and naming, instead of an individual, a qualified trust as the beneficiary.
Even if none of the above events occur, which is unlikely, a substantial sum of money, invested by you in IRA assets, might be completely exposed to confiscatory levels of federal income and estate taxes when your primary beneficiary dies and IRA assets pass to the next generation.
The risk of all of the above problems and concerns for you and your family can be dealt with much better by establishing an IRA Trust and naming, instead of an individual, a qualified trust as the beneficiary.
A standard revocable living trust, designed to handle non tax-deferred assets, typically cannot meet all of the requirements needed under current IRS regulations in order to obtain maximum “stretch out” over the lifetime of the beneficiaries of a revocable trust. Therefore, a separate trust, what we call an IRA Inheritance Trust or Retirement Plan Trust, is established with the proper language and designated as the IRA beneficiary.
Our IRA Inheritance Trusts are specially designed to not only meet current IRS requirements for a qualified “Designated Beneficiary Trust,” in order to achieve maximum income tax-deferral, through stretch out rules, but also provide financial protection against all of the eight problems stated above, that often occur when an individual is named as an outright beneficiary.
If you would like to learn more about how IRA Inheritance Trusts can help maximize the transfer of wealth to your family, please contact me to arrange a complimentary consultation, to see how your family can benefit from establishing an IRA Inheritance Trust.
The Levin Law Firm
150 North Radnor Chester Road
Radnor, PA 19083
Direct Dial: 610-977-1443