Rev Trust as the beneficiary of an IRA
Like many Advisors, I take a comprehensive/relationship approach with my clients. Many clients have significant IRA/401K assets and have stated provisions in their Trust as to whom and when the beneficiaries will get Trust assets as recommended by the Attorney I work with. The Attorney goes into much detail with my clients and often the clients state that a percentage of their assets will go to their children or grandchildren at certain ages – i.e. – 1/4 of their portion to be available at age 35, 1/4 at 40 …etc. The IRA/401K beneficiary is the spouse and the contingent is the Trust. We do state in the Trust that IRA assets will be used to fund the charitable contributions; however, many times IRA funds will pass to children and grandchildren.
I have spoken with my fellow CFP’s in the office and they have the same type of provisions for their clients. My concern is several fold – Is there to be certain wording in the Trust so the funds will transfer to a Beneficiary IRA with the provisions of the Trust? Taxes – the tax implication – is this taxed at the Trust rate? What are the other concerns?
Thanks!
Permalink Submitted by Alan Spross on Mon, 2012-08-27 17:42
There is no specific wording to accomplish these goals, but a trust attorney probably uses a certain amount of boilerplate language to draft the provisions desired. The following is limited general information:
It is good that the death benefits are being expressed in %s rather than dollar amounts. IRA amounts left in trusts that specific dollar amounts creates problems with accelerated taxes (google kenan gain).
Your question appears to assume that the surviving spouse primary beneficiary either pre deceases the client or will execute a qualified disclaimer (Sec 2518) by the 9 month deadline. A beneficiary IRA is then established with the trust as beneficiary. A trust is qualified for look through treatment by meeting the requirements on p 36 of Pub 590. This allows the RMDs to be based on the life expectancy of the oldest trust beneficiary. It is imperative that any charitable beneficiaries in the trust be fully paid before 9/30 of the year following client’s death or the trust will fail qualification requirements.
The trust may contain a wide variety of conditions with respect to the amount and timing of payments to beneficiaries. If these requirements are to be maintained, the trust will have to continue because IRA custodians will not include this amount of conditioned distributions if the IRA is assigned to beneficiaries. The IRA RMDs must meet IRS requirements and be paid to the trust, but if the trust retains these distributions they will be taxed at the highly compressed trust or estate tax rates. Distributions that can be passed through the trust to the beneficiaries on a K-1 can be taxed at the beneficiary individual tax rate. The trustee can have a wide variety of discretion if the trust provisions so state.
It would be possible to condition distributions to beneficiaries until they reach a certain age and after that the trustee could have the authority to assign the remaining IRA interest of a given beneficiary to that beneficiary, and then the beneficiary would have unfettered access to those IRA funds. However, the RMD that such a beneficiary must take does not change as a result of IRA assignment. The oldest trust beneficiary (including remainder beneficiaries) will still determine all beneficiary IRAs even after a share of the IRA is assigned to the individual beneficiary. For that reason, inclusion of a remainder beneficiary (not purely a successor beneficiary) in the trust will damage the stretch available to all the other beneficiaries.
Perhaps Bruce Steiner has additional comments. He is an estate and trust attorney who has published considerable work on this subject, and frequently posts here.
Here is one of those articles:
http://www.kkwc.com/docs/AR20041209132954.pdf
Permalink Submitted by Bruce Steiner on Wed, 2012-08-29 18:06
Alan: thanks for the kind words.
We rarely require distributions at specified ages. We prefer to give the trustees discretion as to distributions. That provides better protection against creditors, including spouses, and keeps the inheritance out of the beneficiaries’ estates for estate tax purposes.
Revocable trusts are overhyped and oversold. While they are appropriate in some cases, and perhaps in some states, for most people they’re unncessary and tend to be a distraction.
Even if a revocable trust is appropriate in a particular case, it’s generally not a good idea to run IRA benefits through a revocable trust. You can simply leave IRA benefits to or in trust for a child, or to charity, as appropriate.
I wouldn’t worry too much about the income tax rates. The trustees can make or not make distributions each year, as they think best, taking into account income tax rates, as well as any other factors they deem appropriate. There is, of course, often a tradeoff between making distributions to beneficiaries in lower income tax brackets versus accumulating income in a trust and perhaps paying a higher income tax rate but better protecting the assets against creditors, including spouses, and keeping the income out of the beneficiaries’ estates.
Permalink Submitted by mk foss on Thu, 2012-08-30 02:53
If a trust is named as the beneficiary of an IRA,it’s best if the trust agreement specifies what is considered trust income when it comes to IRA distributions. If a trust agreement is silent, the trustee is liable if too much or too little is distributed because state law controls. A QTIP trust must distribute all income as defined by an IRS Ruling but the controlling law in some states might not get you there.
I think trusts can solve some problems but they need to be expertly drafted and managed.
Permalink Submitted by Bruce Steiner on Thu, 2012-08-30 13:27
The trusts here are for children and grandchildren. If they are expertly drafted, or even average plus drafted, it shouldn’t matter what’s income and what’s principal.
Mary Kay is correct that in the case of a QTIP trust, the spouse must be entitled to all of the income. While it’s unusual to leave an IRA to a QTIP trust (since you give up rollover and the possible Roth conversion, and the stretchout is generally limited to the spouse’s life expectancy), if you leave an IRA to a QTIP trust, the IRS says that the spouse has to be entitled to all of the income from both the IRA and the QTIP trust. The default law in some states may define income from an IRA in a way that it won’t qualify for QTIP, so if you’re going to leave an IRA to a QTIP trust, you have to make sure the spouse’s income interest in the trust is sufficient to qualify for QTIP.
Alan posted in this thread a link to an article I wrote on trusts as beneficiaries of retirement benefits in the March 2004 issue of BNA Tax Management’s Estates, Gifts & Trusts Journal, which will probably tell you more than you need to know about this subject.
Our clients almost always provide for their children and grandchildren in trust rather than outright, to protect the assets against the beneficiaries’ potential creditors (including spouses), and to keep it out of the beneficiaries’ estates. The same reasons apply to IRAs as other assets. However, given the special rules for trusts as beneficiaries of retirement benefits, we’ll only leave IRA benefits to children and grandchildren in trust if the amount involved is sufficient to warrant administering a trust.