Naming a trust as the designated beneficiary of a client’s IRA has several very important advantages over directly naming the beneficiaries. First, the beneficiary may be a minor, not prudent with money, have marital or creditor issues, or may be disabled. Second, if the beneficiary dies before distribution, the contingent beneficiaries may not be correct. Third, the beneficiary may intentionally or unintentionally withdraw the IRA. However, naming the client’s revocable living trust as the beneficiary, even with the appropriate “conduit-trust” language, may create issues with the operative age for the “stretch-out” of the required minimum distributions. In 2005, the IRS issued Private Letter Ruling 200537044 (the “PLR”) that approved a new type of revocable trust created solely to be the beneficiary of an IRA account. As a result of this PLR, it is now possible for your clients to create a stand-alone trust which provides maximum protection and flexibility.
This IRA Beneficiary Trust insures that your client’s beneficiaries (those who will receive the IRA’s after the client’s death) “stretch-out” their taxable, required minimum IRA distributions over a much longer period of time; with this trust, the age of each beneficiary becomes the operative age for that beneficiary’s required minimum distribution. And, if they do it right, the IRAs can continue to compound for many years income-tax free – – and may literally grow to be worth millions of dollars! This type of trust is also called an IRA trust, a standalone IRA trust, an IRA stretch trust or an IRA protection trust.
If children and grandchildren who inherit IRA funds keep the funds in the IRA for their lifetime and only take the required minimum distributions each year (the “stretch-out”), the amount of wealth that can be retained in the family is very significant. For example, with a $100,000 IRA account and an annualized 8% return: for a 35 year old beneficiary, the total benefit is $1,228,630 and for a 10 year old beneficiary, the total benefit is $5,363,512!
This benefit is obtained only if the beneficiary retains the inherited funds inside the IRA account; if the child (for example) is named as the beneficiary and terminates the IRA account, the benefit is lost. The IRA Beneficiary Trust can insure the stretch-out and can provide the maximum benefit. Even without the normal thought process of a younger beneficiary of “getting everything now”, a beneficiary may not be aware of the tax rules or of the distribution choices, and may allow the IRA to be terminated.
Further, even if the beneficiary retains the IRA account, the account may be reached by creditors or be required to be “spent-down” for governmental entitlements. One of the big advantages to the IRA Beneficiary Trust is the option to give a “Trust Protector” the right to elect out of a straight “conduit-trust” (i.e., where the MRD must be paid to the beneficiary on an annual basis) to a fully discretionary “accumulation trust” (i.e., where the trustee can hold the beneficiary’s MRD inside the trust). This election must be made, if at all, by September 30 of the year following the client’s death. Making this election may result in a shorter “stretch-out” because the age of the oldest “possible beneficiary” must be used (the Trust Protector is also given the power to limit such possible beneficiaries to minimize this issue); however, having this option to elect between the different forms of trusts provides the flexibility to consider all factors known at the time of death and up to the election deadline (e.g., creditor problems, disability, etc.) which may greatly out-weigh the potential increase in the income tax costs.