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”


Playing with Fire? Having an Annuity in Your Traditional IRA

Bigstock-Elder-Couple-With-Bills-3557267Annuities are considered by many to be complex products. Working with IRA required minimum distributions isn’t always an easy trick either. Combine the two, and Kiplinger says, in “RMD Tips: When Your IRA Holds an Annuity,” t it can result in real confusion.

Here are some tips on what you need to know, if you have an annuity in your traditional IRA.

Remember that your required minimum distributions (RMDs) from an IRA must be taken every year beginning in the year when you hit 70½. You can calculate your RMD by dividing the IRA balance as of December 31 of the previous year by a factor based on your age. However, if your IRA holds an annuity, you may have to add its value when figuring your RMD. The type of annuity is important., There are generally three types: immediate, longevity and deferred variable annuities.

The first two types work pretty simply with RMDs. An immediate annuity results in an instant payment stream. It’s typically paid out over the buyer’s life expectancy. This lifetime stream of payments will cover the RMD for the portion of the IRA money invested in it, so that will duplicate the RMD distribution.

Longevity annuities are bought with money now for payouts starting years later (usually age 85). Qualified longevity annuity contracts (“QLACs”) can be purchased with IRA money (up to 25% of retirement account assets or $125,000—whichever is less). Money that is tied up in an IRA QLAC is not counted, when calculating the IRA’s RMD. It’s based solely on any non-annuity holdings.

But owning a deferred variable annuity in an IRA, is where RMDs get a bit hairy. The way you determine the annuity’s value in terms of the RMD, depends on whether it’s been “annuitized.” That means it’s been converted into a stream of payments, usually over the owner’s life expectancy. The rules are different when you annuitize a contract. If the variable annuity is simply an asset in your IRA, its value must be included with the non-annuity holdings when figuring the RMD. Even if you’re withdrawing cash from the annuity, its value on the previous December 31 counts for the RMD. Your insurer may give you an RMD estimate based on the annuity’s value, but that will only cover the annuity. The RMD for any non-annuity IRA holdings must also be calculated, and you can take the total RMD from non-annuity holdings.

Again, when the variable annuity is “annuitized,” the stream of payments will cover the RMD for the IRA value represented by the annuity. Most variable annuities are RMD-friendly, experts say. You’re satisfying the RMD with those payments, and you still have an RMD for the non-annuity holdings.

If you annuitize the contract after you’re subject to RMDs, watch your calculation on the RMD for the first year of payouts. Your RMD in that first year is based on your prior year’s account balance. However, be certain that the total payments you receive during the first year of the annuitized contract are equal to or greater than the calculated RMD. If they’re less, you’ll have to make up the shortfall from non-annuity holdings in your IRA. In later years, the money that’s tied up in the annuitized contract would be excluded from the IRA’s RMD calculation.

Reference: Kiplinger (March 2017) “RMD Tips: When Your IRA Holds an Annuity”


IRA Info for Your Retirement

401k piggy bank“IRAs were established to help Americans save for their future, and retirement savers should take advantage of tax shelters such as IRAs to build and grow their nest eggs.”

A GOBankingRates.com survey found that one in three Americans has saved nothing for retirement. One great way to get started on retirement savings is by using an IRA: Individual Retirement Account.

According to madison.com’s article, “5 Things You Should Know about IRAs,” an IRA is a popular retirement savings vehicle. It lets individuals put money away for the long term, while providing them with tax advantages.

There are two main types of IRAs: traditional and Roth. Contributions made to a traditional IRA may be deductible or non-deductible, and all contributions made to a Roth are non-deductible. Both types of IRA accounts allow money to grow tax-deferred for many years. After age 59½, you can start taking qualified distributions. You’ll typically have to pay income tax on withdrawals from a traditional IRA, but withdrawals from a Roth are tax-free. In addition, here are a few more aspects of the IRA to consider.

  1. Saving for retirement is a solo job, at least when you’re putting money in a tax-sheltered retirement account. An IRA can only have one owner.
  2. IRAs have their own beneficiary designations, so who will inherit an IRA is based on who’s on the account's beneficiary forms—not what’s in a will, trust, or any other estate document. Therefore, when you open an IRA, name a beneficiary and remember to review and update the beneficiary designation form regularly, particularly when you have a life event, such as marriage or a child.
  3. You have until Tax Day to make your IRA contribution for the last year. If you can't make a lump-sum contribution at the start of every year (giving your money added months to compound), you can spread your contributions over a 15-month period, from January until the following March to help you reach the annual contribution limit each year.
  4. You typically must have your own taxable compensation to fund an IRA ( although a working spouse can fund a non-working spouse's IRA.) However, you don't have to use your own money to make your IRA contribution.
  5. Consider rolling all of your 401(k)s into one IRA, which can hold all your old 401(k) money. You can also make direct contributions.

Reference: madison.com (March 13, 2017) “5 Things You Should Know About IRAs”


Making That First RMD

Senior couple at computerIf you turned 70½ last year but did not take the required minimum distribution (RMD) from your IRA, then you had until April 1 of this year. So, did you make it in time?

Kiplinger’s recent article, “Meeting Your First RMD Deadline,” explains that although the IRS is extending the April 15 deadline for filing your tax return to the 18th this year because of the weekend and a Washington, D.C., holiday, there was no break or delay coming for taking your required minimum distribution (RMD).

If you turned 70½ in 2016, you were required to take your first RMD by April 1, 2017 (if you haven't already withdrawn the money). If you didn’t, you'll pay a penalty that’s equal to 50% of the amount of money you should have withdrawn.

Note that if you delayed taking your first RMD, you’ll also have to take the one for age 71 by December 31 of this year. That withdrawal can increase your adjusted gross income a bit. It may also bump you into a higher tax bracket.

In addition, it could make you subject to the Medicare high-income surcharge, if your adjusted gross income (AGI)—plus tax-exempt interest income—totals more than $85,000 if you’re single or $170,000 if you are married and filing jointly.

A good way to shelter your required withdrawal from your AGI, is to make a tax-free transfer from your IRA to a charity. If you're 70½ or older, you can transfer up to $100,000 per year to a charity from your IRA. This will count as your RMD, but it isn't included in your adjusted gross income.

Reference: Kiplinger (March 15, 2017) “Meeting Your First RMD Deadline”


Tax Deductions with Roths and Traditional IRAs

401k eggA 23-year-old single contributes the maximum $18,000 to his Roth 401(k) at work in 2016, and his employer matched $9,000. So, is he allowed to make a tax-deductible contribution to an IRA?

Kiplinger’s article, “Deducting an IRA Contribution on Your Tax Return,” reminds us that anyone who participates in a 401(k) or other retirement plan at work is also able to contribute up to $5,500 to an IRA. The IRS gives you until April 18, 2017 to make a 2016 contribution.

However, a contribution to a traditional IRA may or may not be tax-deductible. Because the 23-year-old single in our example, is covered by a retirement plan at work, he is only allowed to deduct his traditional IRA contribution, if his modified adjusted gross income (AGI) for 2016 was less than $71,000 (because he's single). This deductible amount begins to phase out when a person’s income is $61,000 or higher. However, there’s no maximum income limit for deducting traditional IRA contributions, if you aren't covered by a 401(k) or other retirement plan by an employer.

Married individuals covered by a retirement plan at work are allowed to deduct their traditional IRA contributions, if their joint income was less than $118,000 in 2016. The deduction starts to phase out at $98,000. If you weren’t covered by an employer’s retirement plan but your spouse was, your IRA contributions can be tax-deductible, if your joint income in 2016 was less than $194,000 (the deduction amount starts to phase out at $184,000). There's no maximum income limit for making tax-deductible contributions, if neither spouse is covered by a work retirement plan.

Even though the 23-year-old single in our example is eligible to deduct traditional IRA contributions, he may want to contribute to a Roth IRA instead. He can’t deduct Roth IRA contributions (and his Roth 401(k) contributions are also after taxes), but the money grows tax-free for retirement. He can also withdraw his contributions without a penalty or taxes at any time. Since he's young, and his income will likely increase over time and push him into a higher tax bracket, the benefit of tax-free growth in the Roth IRA is likely to be better than the benefit of receiving a tax deduction for traditional IRA contributions now.

Studies have shown that, especially for younger investors, Roth IRAs result in much more after-tax money during retirement than traditional IRAs. If tax rates increase in the future, the Roth will be beneficial, and it has no required minimum distributions (RMDs) after you turn 70 ½.

You’re able to contribute the full $5,500 to a Roth IRA for 2016, if your modified adjusted gross income was less than $117,000 for singles or $184,000 if you’re married filing jointly. The amount you’re able to contribute phases out until your income reaches $132,000 for singles and $194,000 if married filing jointly. The income limits are slightly higher for 2017 contributions.

Reference: Kiplinger (February 3, 2017) “Deducting an IRA Contribution on Your Tax Return”

1 2 3

  • Fill in the form below to download your e-book

    Download your free Avoid These Five Common Estate Planning Myths e-book
  • This field is for validation purposes and should be left unchanged.