Pitfalls of IRA’s in Estate Planning by David Disraeli

Retirement assets can become a large portion of a person or family’s net worth.  Due to the tax deferred nature of IRA and 401k assets, estate planning around these funds can become highly complex.  For purposes of this article, we will call 401k, 403b, IRA or any type of retirement assets “IRA’s”.

Generally people name their spouse first and children second (if applicable) as beneficiaries of their IRA assets.  The spouse can continue the IRA as their own, even if the deceased already began taking the RMD’s (required minimum distributions).  For a younger spouse this allows them to continue deferral.  This tool is only available to spouses.  Any other beneficiary is required to take the assets and pay taxes in one of three ways:  immediately, over five years, or over their life expectancy.  The layman’s term for the latter is called a “stretch” IRA.  For someone in their 30’s, as an example, the possibility exists to for the IRA to double, quadruple or more.  All this sounds great right?  Perhaps, but perhaps not.

What if the surviving spouse is not great with money and the IRA is rather large?  What if the spouse remarries and names the new spouse as beneficiary – disinheriting your children?  What if your heirs predecease you or take your IRA and leave it to a non-family member?  What if a beneficiary is a minor because the parent is deceased?

The adverse possibilities are endless.  Further, The U.S. Supreme Court recently ruled in Clark v. Rameker (13-299) that inherited IRAs are not protected in bankruptcy.

What if you knew of a way to control your IRA from the grave?  This means determining in advance who the ultimate beneficiaries are, how much they can withdraw and when?  While they are required to take the minimum distribution based on their age (no 59 1/2 penalty under inherited IRA rules), it is chump change compared to the total.  The good news is that there is a tool to allow you to protect your legacy from unintended consequences and dissipation.

The solution referred to is a special type of trust.  IRS regulations and plenty of guidance from private letter rulings outline a method of drafting a trust that is disregarded for tax purposes but not for estate planning purposes.  Generally if a non person (trust, LLC etc.) is named as a beneficiary of an IRA, the proceeds are taxed immediately at the highest marginal rate.  However the IRS has laid out the blueprint for a trust to be the beneficiary but uses the life expectancy of the oldest beneficiary as the method of calculating the RMD.  In that sense the trust is disregarded.  The scope of the complexities of of this type of arrangement are beyond a blog post.  There are specific drafting requirements, exact beneficiary naming procedures, and other considerations.

The bottom line is if you want your wealth to stay in your family, and be assured of it, there is a mechanism available.  For a free consultation on this or any other estate planning topic, call David Disraeli a 512-464-1110 or book a call here.