A Trusteed IRA May be a Wise Solution

Definition of trustFinancial Planning’s article, “When you should establish an IRA as a trust,” advises that the answer depends on several factors, like the amount of control you want beneficiaries to have.

Tax laws say that an IRA can be established as a trust or custodial account. With a trusteed IRA, a financial organization adds trust terms and language to the plan, so the IRA itself becomes a trust. The financial organization acts as the trustee. The account is administered under the trust provisions both before and after the IRA owner’s death. The owner typically has greater control and provides less control for beneficiaries.

A trusteed IRA is effectively a conduit trust where the trustee must pay out the annual required minimum distributions to the beneficiaries. In order to ensure the stretch IRA for beneficiaries, some trusteed IRAs also allow distributions beyond the RMDs for health, education, and other support.  However, trusteed IRAs are standardized documents, so there will likely be some limits on the post-death control options.

Those who have large IRAs and other extensive assets, already may be using trusts as part of their overall estate planning strategy. For those individuals, costs are not a concern and they’d likely be best-served by naming a trust as their IRA beneficiary. For others, whose IRA is their largest asset, a trusteed IRA may make sense. A trusteed IRA usually costs less than a trust to create.

An advantage of a trusteed IRA is: if the IRA owner becomes incapacitated, trusteed IRAs often have a provision that lets the trustee take the RMD on their behalf. Some trusteed IRAs also allow distributions beyond the required minimum distributions for health, education, and other support. This wouldn’t be possible with a trust or an individual named on the IRA’s beneficiary designation form. The trustee can also make lifetime investment decisions and pay any IRA-related fees or expenses.

A trusteed IRA may be a good strategy for those whose primary concern is preserving the stretch for their beneficiaries, because it can limit yearly distributions to the amount of the RMD and preserve the stretch IRA.  However, if a trust is named as the beneficiary of an IRA, and it meets the look-through rules, the beneficiary of the trust can use the stretch and take RMDs over the life expectancy of the oldest trust beneficiary.

When an IRA owner names a beneficiary outright, the owner has no say in what happens to the funds after the death of the beneficiary. But a trusteed IRA gives the IRA owner the ability to name successor beneficiaries, which can be useful in second-marriages, where the IRA owner wants to provide for a spouse during his or her lifetime but then ensure that the IRA funds go to children from a prior marriage.

A trusteed IRA offers a higher level of protection from creditors than leaving assets outright to a beneficiary. However, this is somewhat tempered by the fact that the trusteed IRA must to pay out the RMDs each year to the beneficiary, and there’s no way to protect the RMD funds.

 It is possible to name a trust as the IRA beneficiary to gain a higher level of protection. A trust could be created to give the trustee the discretion to keep the RMDs in the trust, instead of paying them out to the beneficiaries. The downside to using a trust to protect the RMDs from creditors is the tax at trust tax rates of up to the top 39.6% income tax bracket. A Roth IRA left to a trust could avoid this issue.

Those considering trusts often want to appoint an individual as a trustee. Sometimes, it’s an individual as co-trustee with a financial organization. This won’t work with a trusteed IRA, because the trustee will be the financial organization offering the trusteed IRA. The tax code doesn’t permit an individual to be a trustee of an IRA.

A drawback to trusteed IRAs is the lack of ability to move the inherited IRA assets. There’s no reason why a trusteed IRA couldn’t allow the movement of inherited IRA funds after the death of the IRA owner, but these documents are usually drafted so that it’s either prohibited or not guaranteed.

Trusteed IRAs may not be the solution for everyone.  Therefore, you should think about just designating a beneficiary directly on the IRA beneficiary form or naming a trust that’s been created by a trust attorney.

Reference: Financial Planning (May 31, 2017) “When you should establish an IRA as a trust”


Secret Details for IRAs

401k eggOne potential benefit of IRAs is creditor protection in the case of a bankruptcy. However, when you die, you may wonder if your beneficiaries are protected. Forbes recently published an article, “Estate Planning Tip: Creditor Protection for IRAs & Beneficiaries,” that says investors need to know how their assets can be better protected in the event of bankruptcy or lawsuits. We’ll look at some of the issues facing IRA investors and their beneficiaries when it comes to bankruptcy and items to think about when naming an IRA beneficiary.

Bankruptcy. Similar to the protection offered to pensions, 401(k)s and Social Security benefits, IRAs can be protected from creditors in bankruptcy. If you declare bankruptcy, your IRA assets will typically be safeguarded and can’t be taken. However, this doesn’t extend to other types of judgments, civil lawsuits, or IRS levies. State laws will vary, but your IRA assets may be protected from other creditors. There is a $1 million inflation-adjusted limit that applies to federal bankruptcy protection rules for the aggregate value of Contributory and Roth IRAs (with inflation, the limit is $1,283,025 as of April 1, 2016). Assets rolled over to an IRA from a qualified plan, like a 401(k), aren’t subject to the same dollar limits and can be fully protected.

Beneficiaries Protection. A big benefit to IRAs is the simplicity in selecting a beneficiary to receive the money when you die. This can be a great estate planning tool because these assets are not subject to probate and pass directly to the beneficiary. Make sure that your beneficiary designations line up with your overall estate planning goals. However, beneficiaries of IRAs are not always given the same creditor protection as the original account owner, so you need to consider this when selecting your IRA beneficiary. An inherited IRA for a non-spouse beneficiary is no longer automatically protected from creditor’s claims when the beneficiary files for bankruptcy. When the owner dies, and the non-spouse beneficiary takes ownership of the account, the assets are no longer deemed retirement funds, and can be seized in bankruptcy. This only applies to non-spouse beneficiaries because a spouse can roll over inherited IRA assets into his or her own account. When this transfer occurs to a surviving spouse, the assets are once again protected. However, a non-spouse beneficiary can’t comingle inherited IRA assets with their own retirement assets. Check your state laws on the degree of protection over non-spousal inherited retirement funds.

Children as beneficiaries. Many parents opt for their children to be beneficiaries of their IRA accounts. This can be an issue if the children have financial issues or face debt collectors. You can get around this be creating a conduit trust, and by listing the trust as beneficiary of the IRA and not the child. As a result, an inherited IRA payable to a trust can be protected from the child’s creditors while still allowing the child to benefit from the inheritance. The IRA’s required minimum distributions are calculated on the trust beneficiary’s life expectancy, and income is taxed at the beneficiary’s tax rate. Since the assets aren’t legally owned by the beneficiary, they’re protected from creditors in most instances. However, keep in mind that once the income is paid out to the beneficiary, that income isn’t protected.

It is important to review your beneficiary designations regularly because your goals and circumstances may change over the years. If a beneficiary is experiencing financial difficulties, you may want to try to protect them and to protect your legacy. In addition, the laws can change over time, and there may be particular nuances to creditor protection in your state. You should speak with a qualified estate planning attorney before you make any changes.

Reference: Forbes (December 9, 2016) “Estate Planning Tip: Creditor Protection for IRAs & Beneficiaries”

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