Estate Planning & IRAs
Sum mary
Information on how selecting a beneficiary of a traditional IRA can affect estate planning.
Introduction
An IRA beneficiary designation should be part of a comprehensive estate plan unique to each individual. There is no standard or “boilerplate” beneficiary designation that can be advised for all clients. When determining the proper beneficiary designation, consideration should be given to issues such as planning for estate taxes, multiple marriages, spendthrift or special-needs children.
Consideration should also be given to issues unique to lRAs such as the required minimum distribution (“RMD”) rules. The client must balance these sometimes-competing interests when making their beneficiary selection.
• The selection process
• Individual as beneficiary
• Spouse as beneficiary
• Charity as beneficiary
• Trust as beneficiary
• What qualifies a trust?
The selection process
1. Determine the person or entities that should benefit from the IRA following their death.
2. Determine if there are any special estate planning factors that should be taken into consideration. Here are some estate planning factors to consider:
• Does the client have creditor protection concerns for any of the beneficiaries?
• Does the client have children from a prior marriage?
• Does the client have spendthrift children?
• Does the client have any “special needs” children?
• Is the IRA necessary to fund a credit shelter trust at their death?
3. Determine the consequences of the beneficiary designation upon the required minimum distribution rules. For example, a client may prefer to name a marital trust as the beneficiary to ensure that children from a prior marriage have the possibility of receiving unused benefits upon the spouse’s death. However, by naming the marital trust as the beneficiary, the client’s spouse will be denied the opportunity to benefit from the spousal rollover rules.
4. Are the intended beneficiaries considered Designated Beneficiaries? To be considered a Designated Beneficiary and to take advantage of the tax deferral opportunities of an IRA, those named must either be:
• An individual OR
• A “qualified trust”
Individual as beneficiary
Naming an individual as the beneficiary of the clients IRA is the simplest form of beneficiary designation. Absent any special estate-planning considerations, many planners also consider it the preferred form of beneficiary designation as it may be more likely to achieve tax deferral opportunities.
Spouse as beneficiary
For most married people, the spouse is usually the first choice as beneficiary. A spouse, as an individual, will have the opportunity to benefit from continued tax deferred growth of the account.
A spouse also has additional options not available to other beneficiaries. The spouse may choose to begin distributions from the IRA by December 31st of the year following the year of the client’s death. If the spouse is the sole beneficiary, they may use the more advantageous recalculation/fixed-term combination method of calculating RMDs.
A spouse also has the ability to “rollover” the deceased client’s IRA to the spouse’s IRA with no immediate income tax consequences. If the spouse is the sole beneficiary, they also have the opportunity to treat the IRA as their own or to delay distributions until such time as the deceased client would have attained the age of 70 ½.
Charity as beneficiary
If a client is charitably inclined and has an IRA, the client may want to consider naming the charity as the IRA beneficiary. If the charity is qualified as a tax-exempt entity under Section 501(c) (3) of the Internal Revenue Code, it can take an immediate distribution of the entire IRA balance without having to pay any income taxes. This may allow for a greater benefit to the client’s intended recipients.
Trust as beneficiary
Many people have named their revocable trust as the beneficiary of their IRA in order to allow for a
comprehensive administration of all of their assets at their death. At first glance, this may seem like a
good idea. However, a number of complications can arise by naming a trust as the beneficiary.
Consequently, unless you have other estate-planning reasons, it may be more appropriate to name individuals directly. If there are estate planning reasons that warrant naming a trust as the beneficiary (ex. a second marriage, a spendthrift child, a need to fund a credit-shelter trust, etc.), care should be taken by the attorney drafting the trust.
To ensure that the trust can take advantage of the benefits of continued income tax deferral inside the IRA, the trust must be a “qualified trust.” This means that the IRS could look through the trust and treat the trust beneficiaries as if they were named directly as beneficiaries of the IRA.
What qualifies a trust?
To be considered a “qualified trust”, the trust must meet the following requirements:
1. The trust is a valid trust under state law or would be but for the fact that there is no corpus.
2. The trust must be irrevocable or will, by its terms, become irrevocable upon the death of the
participant. Generally, most revocable living trusts become irrevocable at the client’s death thereby satisfying this requirement. Also, a testamentary trust meets this requirement despite the fact that it is not yet in existence at the time of client’s death.
3. The trust beneficiaries must be identifiable from the trust document. The beneficiary does not need to be specified by name. The members of a class of beneficiaries capable of expansion or contraction will be treated as being identifiable if it is possible to identify the class member with the shortest life expectancy.
4. Certain trust documentation must be provided to the plan administrator. A copy of the trust or a summary of the trust listing all of the beneficiaries must be delivered to the IRA trustee or custodian by October 31 of the year following the year of the client’s death.
5. All beneficiaries of the trust must be individuals. A trust with a charity or an estate as a beneficiary would not meet this requirement.