inherited ira and minor beneficiaries
My mom passed away in December of 2011. The primary bendficiary of her IRA is her trust. Her trust qualifies as a see-through trust with beneficiaries of her two daughters, receiving one-third and three grandchildren, receiving one-ninth. All three grandchildren are minors. Two attorneys, a tax advisor and a financial planner have all given advice without agreement. They all agree that my sister and I can set up inherited IRAs but there is disagreement surrounding the grandchildren. One attorney believes that inherited IRAs can be set up for them; the other does not, believing the IRA would remain as part of my mom’s trust, with RMDs, until the minors reach 25 (this is the age, outlined in my mom’s trust). At age 25, he believes individual inherited IRAS could be set up for the grandchildren. It is so frustrating and confusing. I was hoping you could shed some light on this perplexing problem. Thanks so much, Rhonda
Permalink Submitted by Alan Spross on Tue, 2012-09-25 00:45
The terms of the trust govern when a trust beneficiary interest can be distributed out of the trust. The attorney who drafted the trust should know what the trust says in that respect. The RMD is the easy part, since a qualified trust must take RMDs using the life expectancy of the oldest trust beneficiary. Whether the RMDs or other additional distributions allowed are retained in the trust and taxes paid at the higher compressed trust rates depend again on the terms of the trust. Otherwise, the income could be passed through the trust and reported on the individual beneficiary’s tax return. State law will also come into play if the minor’s interest in the IRA can be distributed to inherited IRAs and who will be the responsible party in that case.
But regardless of whether the inherited IRAs can be created or not, the RMDs are determined by the oldest daughter attained in the year following her death. The trustee of the trust is also responsible for completing the year of death RMD (2011) if your mom passed after her required beginning date and did not complete the 2011 RMD.
Here is an article by noted retirement plan attorney Natalie Choate on the subject of establishing inherited IRA accounts for trust or estate beneficiaries:
http://www.ataxplan.com/bulletinBoard/ira_providers.cfm
The article will help with the mechanics regarding IRA custodians, but if the trust is not clear regarding termination and distribution of the IRA and other interest, there could be additional legal expenses.
Permalink Submitted by rhonda todd on Tue, 2012-09-25 01:26
Thanks so much for your reply. Do i understand you correctly when you state that laws vary, regarding inherited IRAs, by state? Both attorneys have quoted Natalie Choate and numerous PLRs to support their differing opinions but neither has quoted Iowa state law. I can’t imagine that this is such an unusual case that there isn’t precedent but I am baffled at the responses from two highly educated attorneys.
Permalink Submitted by Bruce Steiner on Tue, 2012-09-25 01:37
Unfortunately this isn’t so unusual. I question how educated the two lawyers are. If the facts are as you describe, the big error was running the IRA through the (revocable?) trust. If the IRA owner had simply left the IRA to (or, if the amount was enough to warrant administering separate trusts, to separate trusts for) the 5 beneficiaries, each one could use her own life expectancy, or perhaps the two daughters could each use the older daughter’s life expectancy and the three grandchildren could each use the oldest grandchild’s life expectancy. Given that error, I wouldn’t give much weight to the advice from the lawyer who planned the estate.
Of course, without seeing the trust, we don’t know what it says, or if the facts are as you describe.
The rules governing IRA distributions are based on Federal law, and the trust says what it says.
For more on trusts as beneficiaries of retirement benefits, see my article on that subject in the March 2004 issue of BNA Tax Management’s Estates, Gifts & Tax Journal: http://www.kkwc.com/bio.php?r=30 .
This is one more example of how the interplay of revocable trusts and IRAs creates problems, and in this case the loss of substantial tax benefits. Revocable trusts are overhyped, oversold, do not save taxes, and except in a few states not necessary for most people.
I suggest consulting with tax/estates counsel familiar with these issues.
Permalink Submitted by Alan Spross on Tue, 2012-09-25 01:41
State law would come into play with respect to how the inherited IRA for the minors would be set up if the trust even allowed this. In some states an UTMA account may need to be established to receive the RMDs for the minors, in other states it might be the responsibility of a court appointed guardian for the minors. State law may also come into play with respect to various trust requirements, but not with respect to RMDs.
The problem here is that the minors RMD will be much larger than if they were named outright as beneficiaries rather than in trust since the oldest daughters age must be used for all RMDs. However, the trust may provide protection against the minors just draining their share when they reach the age of majority in Iowa. Theres a trade off there. The authority vested in the trustee of the trust may allow discretion on certain issues. Trust provisions can vary considerably in several respects.
The worst error the trustee could make at any time would be to order a large or total distribution because for a non spouse inherited IRAs there are no rollovers allowed. Funds can only be moved by direct IRA trustee transfers. Any distributions paid to the trust are irrevocably taxable. The trust trustee will also have some heavy accounting responsibilities here keeping track of the 5 different interests in IRA distributions. And speaking of 5 interests, what about unborn grandchildren?
Permalink Submitted by rhonda todd on Tue, 2012-09-25 02:35
For clarification purposes, my mom’s trust was set up as a revocable trust. Upon death, the trust principle was to be divided into equal shares, “one share to daughter A, one share to daughter B, and one share to be distributed into equal shares to grand-daughter C, grand-daughter D, and grandson E”. The trust further states that the trustee shall “withhold any principle which is otherwise required to be distributed to a beneficiary who has not reached the age of twenty-five years or is disabled. The trustee shall retain any principle so withheld in a separate trust named for that beneficiary, to be distributed to the beneficiary when he or she reaches the age of twenty-five years, or if later, upon termination of the disability”.
It seems to me her trust is clear. The problem is the custodian (M-L) of her IRA has a beneficiary form on file from 2000 with the primary beneficiary being the trust. Secondary beneficiaries are equal shares to daughter A, daughter B and grand-daughter C. Thus, disclaiming wasn’t an option for it severely penalized grand-daughter D and grandson E. This is why it has been recommended to set up inherited IRAs.
I am just trying to seek advice from other sources in an attempt to avoid a huge mistake and a large taxable consequence of doing something incorrectly. I will find out about the state of Iowa law, governing this issue and I have printed off your article, Mr. Steiner, which I will read tonight. Again, I am just appreciative that you both took of your valuable time to answer my questions…
Permalink Submitted by Bruce Steiner on Tue, 2012-09-25 03:35
You said “the problem is the custodian (M-L) of her IRA has a beneficiary form on file from 2000 with the primary beneficiary being the trust.” The custodian isn’t responsible for what the beneficiary designation form says. The IRA owner had to sign it.
Setting up the inherited IRAs shouldn’t be particularly difficult. It’s possible, though, that the custodian will want a legal opinion that the trustees of the revocable trust can distribute the IRA in kind to the daughters and the grandchildren’s trusts.
The major error was made when the IRA owner left the IRA to the revocable trust, thus limiting the grandchildren’s trusts to at most the life expectancy of the older daughter instead of to the life expectancy of the oldest grandchild.
You’ll also have to look at the trust to make sure there’s nothing in it that would prevent the inherited IRAs from being stretched out over the older daughter’s life expectancy. Often there’s something in a revocable trust that would prevent such a stretchout.
The provision of the trust that you quoted that the trustee is to “withhold any principal which is otherwise required to be distributed to a beneficiary who has not reached the age of twenty-five years or is disabled” doesn’t make sense. Why should there otherwise be a requirement to distribute principal? What if the trustees think it best to make a principal distribution? What about the income? Perhaps you’ve provided this out of context, and the dispositive provisions, taken together, make sense.
Permalink Submitted by Alan Spross on Tue, 2012-09-25 04:08
Perhaps the daughter’s shares can be assigned to their own inherited IRAs, but the spin off trusts for each GC will have to continue with those trusts paying the taxes on the RMDs at the higher rates.
If so, the daughters RMDs will not be much different different than if they had been named as designated beneficiaries on the IRA (younger one will have a higher RMD).
Check prior tax records of your mother to determine if there was any basis in her IRA from non deductible contributions. Look for Form 8606. Also, be sure that the trust documents are properly provided to the IRA custodian no later than the upcoming 10/31 deadline.
If the IRA custodian causes any issues, the IRA can be transferred in total to another custodian, but ML is certainly has resources enough to deal with these issues.
Permalink Submitted by rhonda todd on Tue, 2012-09-25 04:11
I don’t mean to make this more confusing. I am just trying to clarify different opinions that I have received. Here is a letter from one attorney to another. Perhaps this will shed light on the differing opinions.
” I have reviewed the information that you sent to me on September 19, 2012. After reviewing this information, I conclude that we are both partially correct with our positions. Please review the “Noah Example” on page 404 of Natalie’s book. From this example, I think we can recommend the following to Daughter A and Daugher B:
a. Mary’s IRA may be separated into five separate inherited IRAs, one inherited IRA for each of the trust remainder beneficiary.
b. Annual minimum required distributions must be made from all five separate IRAs based on Daughter A’s life expectancy.
c. Daughter A and Daughter B may make investment and distribution decisions for their separate inherited IRAs, so long as they each withdrawal the required minimum amount each year from the IRA and, as stated in b., above, the minimum amount is calculated by using the life expectancy divisor based on Daughter A’s age.
d. The inherited IRAs for the three grandchildren, Grand-daughter C, Grand-daughter D, and Grandson E, must retain the trust’s EIN, and the required minimum distributions from the three separate inherited IRAs must be paid to the trust and are subject to the terms of the Mary’s trust for the three grandchildren.
e. Once a grandchild attains age 25, the grandchild’s IRA can be released from the trust and the distributions can be made directly to the grandchild.
f. Mary’s trust must continue to maintain a checking account to receive the distribution from the three IRAs for the three grandchildren. Mary’s trust must also file income tax returns each year to report the taxable income received from the IRAs. The trust must file income tax returns until the year after Grandson E attains age 25.
I think it is important for Daughter A and Daughter B to understand that there is no clear definitive authority for separating out the IRAs in this particular situation. Natalie Choate’s explanation only provides a list of revenue rulings for situations with a trust is terminating and no definite authority is cited for the Noah Example on page 404. I also think it is important for Daughter A and Daughter B to acknowledge the risk that if the IRS audits Mary’s fiduciary income tax returns, their individual income tax returns, or the grandchildren’s income tax returns, the IRS may determine the separation of the IRA was a taxable event at the time the IRA was separated. While we can express to Scottie and Rhonda, that while the risk of an IRS audit is not high, we can’t guarantee that an IRS audit won’t occur and we can’t give them assurance that the IRS will treat the separation of the IRA as a non-taxable event because we only have authority that is not exactly on point and is not binding on the IRS.”
One attorney believes that separation might be a taxable event…The other does not. Obviously, there are huge tax ramifications to this differing opinion.
Permalink Submitted by Alan Spross on Tue, 2012-09-25 04:38
I don’t see any reason that this would be a taxable event as long as the transfers are done directly. That possibility is probably more about protecting their interests against a professional liability claim.
Most of the opinion makes good sense. One issue is whether separate sub trusts need to be established for each GC or not. If so, each sub trust would have it’s own EIN and 1041. Either way, I see no reason to think that there is any taxable distribution until funds are distributed out of the IRA. Even if the trusts are set up incorrectly, the IRA can just be retitled to correct the error.
I have never seen a post on these boards reporting unexpected IRS rulings regarding trusts and RMDs or heard of any from various other sources. Bruce Steiner would be the first to know if there were any such cases.
Permalink Submitted by rhonda todd on Tue, 2012-09-25 04:53
Thank you so much, Mr. Oniras. Your responses have been very helpful. And it’s refreshing to get an opinion from people who just genuinely want to help.
Permalink Submitted by Bruce Steiner on Tue, 2012-09-25 13:12
a, b and c are correct unless there’s something in the trust that would make the stretchout over the older daughter’s life expectancy unavailable. That’s sometimes the case when IRA benefits are run through a revocable trust.
As to d and e, it depends on the terms of the trust, but there’s often a way to divide a trust (which would allow each grandchild’s trust to be invested differently, or distributions to be made to each grandchild out of his/her share, if distributions are permitted).
f is clearly incorrect. No one is required to have a checking account.
If you want certainty as to the result, you can apply for your own private letter ruling. A private letter ruling is binding on the IRS with respect to the taxpayers to whom it is issued, but is not binding on the IRS with respect to others.
I suggest consulting with competent tax/estates counsel familiar with these issues.