Trust As Beneficiary Of An IRA? Let’s Take A Look.

Last week, a very nice man from Orleans came to see me; let’s call him David. David is 72 and has been married to his wife, Judy, for 52 years. They have three children and seven grandchildren. David took a class that Susan and I teach at Cape Cod Community College on building retirement systems and he was eager to get to work.
David’s desire to create such a system is not uncommon. Like so many folks, David worked hard his whole life, raising three kids and saving for retirement in the hopes that, one day, time would be his own. But until now, he never really thought about creating a system.
Both David and Judy have some pretty good-sized IRAs. So, after helping him design an effective investment and income plan, we talked about their estate and legacy plans. Part of that discussion involved determining if David and Judy have designated appropriate beneficiaries for their IRAs. You see, money in IRAs will not normally be distributed, pursuant to the provisions of a will. This is because typically, when establishing an IRA, beneficiaries are designated in the paperwork submitted to the custodian of the account (such designations can be amended by signing a change in beneficiary form). Named beneficiaries can include a spouse, children, grandchildren, trusts and/or charities.
In my practice, I find that most married people designate their spouse as the primary beneficiary of their retirement accounts. But in David and Judy’s case, they named a trust as the beneficiary of both of their IRAs. I was very interested to know why they decided to do this—so I asked David. He kind of smiled at me and said it was done a long time ago and he does not remember why.
Folks, IRAs have been around for decades. In fact, the first year they were available was 1975. Many of today’s retirees established their IRAs years ago and, like David, spent both time and money drafting trusts to name as the beneficiary of their retirement accounts and have not thought about it since they did. Actually, Susan and I see trusts listed as beneficiaries quite often, with no clear definition as to why. This week, let’s talk about some reasons why it may be a good idea to reconsider that decision.
Susan and I like to explain to our clients that trusts offer control from the grave and if you name a trust as the beneficiary of your IRA assets, you may have more control over the timing or circumstances of any future distributions. While this may sound desirable, there is a tradeoff for that control. Trusts can be complicated and even more so when they are named as IRA beneficiaries, due to the special tax rules applicable to IRAs.
For most people, there is no federal tax benefit to naming a trust as a beneficiary. Previously, credit shelter trusts were used to minimize federal estate taxes paid by married individuals when leaving assets to their heirs. However, the federal estate tax exemption is much higher now than when these trusts were commonly used. In fact, with the portability provision available for the federal estate tax for married couples, married couples can leave up to $10.98 million tax-free. These changes mean that the federal estate tax is now a concern for only a very small percentage of estates.
I know I am getting technical here, but stay with me . . . if you named a credit shelter trust as the beneficiary of your IRA as part of an estate tax planning strategy when the exemption was much lower, you may no longer need that trust.
Nevertheless, the Massachusetts estate tax exemption is much lower: $1 million. Therefore, trusts are often used as an estate tax planning tool in order to minimize any potential state estate tax.
Therefore, you should consult with a knowledgeable retirement financial planner and estate planning attorney if you find that your assets total more than $1 million, keeping in mind that anything you own or control is included in that calculation (retirement accounts, real estate, life insurance policies . . .).
Another reason to reconsider naming a trust as the beneficiary of an IRA is the tax schedule applicable to trusts. Generally speaking in 2017, for a married couple filing jointly, the 39.6 percent tax rate kicks in when taxable income exceeds $470,700. Generally for a trust, a higher tax rate kicks in when trust taxable income exceeds only $12,500! If income from the IRA will be taxable to your trust, that is a serious tax hit. Don’t you think Uncle Sam has gotten enough out of you? And he is not even your real uncle. As always, we suggest you speak to a CPA to see where you fit in.
For purposes of “stretching” an IRA over the lifetime of both a spouse and the surviving spouse’s heirs, it may make sense for an IRA to be taken as a spousal rollover, rather than left to a trust with the spouse listed as one of the beneficiaries. This is because if the trust is structured correctly and the IRA can be “stretched,” the age of the oldest trust beneficiary is used to determine the life expectancy on which the required minimum distributions from the inherited IRA will be based. If the IRA is initially passed on as a spousal rollover, then the RMDs will be calculated based on the surviving spouse’s life expectancy, but only for the life of that surviving spouse. After the surviving spouse dies, if the IRA is then left to a trust, the RMDs will be calculated by using the date of birth of the surviving spouse’s oldest heir. This strategy may give those younger heirs a longer period over which distributions can be stretched, preserving the tax benefit for as long as possible.
Most importantly, ask yourself why you have a trust. Was there a good reason to establish one? If you have named your trust as the beneficiary of your IRA, why did you do that? Do the reasons for your decision to do so still exist today? We find that for most folks who we consult with, more often than not, they do not know the answers to these questions.
I reached out to attorney Geoff Nickerson of Oppenheim & Nickerson LLP, a law firm in Falmouth, for his input. Geoff notes that trusts are often specialized to meet clients’ needs. “Trusts come in all types. Just as when you walk into an ice cream shop and ask for a cone, you will be met with the question, ‘What kind?’ When you meet with your estate planning attorney, do not be surprised to have him or her ask several followup questions if you tell them that you need a trust.
The purpose of these questions is to focus in on your goals and needs. Preserving assets after your death might be best accomplished by a family trust. As Jeff notes, more complex marital trust estate plans “would be appropriate for those with significant wealth. IRA trusts are specialized vehicles, and require discussion with your financial and estate planning counsel, and possibly with your accountant or tax professional about tax consequences and long-term planning considerations. And for those with heirs who have special considerations, a supplemental needs trust might be the proper vehicle. Your meeting with your counsel is intended to be a dialogue to ensure that the trust will accomplish your goals.”
Good advice, Geoff! This guy gets it.
Now, there may be very good reasons to have a trust and to have named that trust as the beneficiary of your IRA, but you need to understand those reasons. Just as with any strategy, we never look at good or bad, only whether a strategy is appropriate or inappropriate.
Be vigilant and stay alert, because you folks deserve the best.