Bloomington, Indiana Retirement Benefits Planning Lawyer

Estate Planning with Retirement Accounts

Although we do not offer financial and investment advice, we do advise our clients on the best way to handle estate planning for their retirement assets. Whether you have a 401k, 403b, 457b, IRA, or some combination, you need to understand that these are special assets that may require special planning.

Unless the account is a Roth IRA, or similar, your beneficiary will have to pay income tax on the inherited retirement account. There are special rules that may allow the beneficiary to “stretch-out” the distributions over his/her life expectancy, and thereby defer paying the income tax over a long period of time. However, naming a person outright as beneficiary is fraught with potential problems.

First, the beneficiary may blow the opportunity to stretch-out distributions thereby losing the incredible financial compounding benefit of keeping the funds within the retirement account as long as possible. For example, a 25-year-old who inherits a $100,000 IRA may choose to withdraw that money and buy a $60,000 automobile (the amount after cashing in the IRA and paying the income tax). However, if the beneficiary would have been smart about it, he/she would have had over $400,000 in after-tax income over his or her life expectancy (based on 5% growth and combined state and federal income tax of 35%). If your goal is to preserve tax-deferred growth, it is advisable to have a trustee involved who will ensure that happens.

The second problem with naming a person outright as beneficiary is that the beneficiary could lose the inherited retirement account to creditors, or predators (such as a divorcing spouse).  In a landmark, unanimous 9-0 decision handed down on June 12, 2014, the United States Supreme Court held that inherited IRAs are not “retirement funds” within the meaning of federal bankruptcy law. This means they are therefore available to satisfy creditors’ claims.  (See Clark, et ux v. Rameker, 573 U.S. ______ (2014)). Thus, if you wish to protect the inherited retirement account for your loved one the use of a trust now appears to be the only way to do so.

Trust as Beneficiary
There are two common myths about estate planning for qualified retirement plans and IRAs:

(1)  You cannot name a trust as beneficiary and get a stretch-out; and

(2)  Naming an individual as beneficiary will result in a stretch-out.

As shown in the above example, the problem with naming an individual as beneficiary is that he or she is likely to cash out the IRA or retirement plan account, thus negating the participant’s careful planning for long-term tax-deferred growth.

We have found that many people, including some financial advisors, are misinformed and believe naming a trust as beneficiary of retirement plan assets will cause immediate income taxation when the participant dies (or at least within 5-years of the participant’s death). Assuming the trust is properly drafted, this is absolutely not true.

Planning Tip:  In most cases a standard revocable living trust agreement will not be well-suited to be named as the beneficiary of an IRA.  This is because in order to provide all of the benefits listed above and avoid mandatory liquidation of the inherited IRA over a period as short as five years, the trust agreement must be carefully crafted as a “See Through Trust.”  A See Through Trust insures that the required minimum distributions can either remain inside the trust (an “accumulation trust”), or be paid out over the oldest trust beneficiary’s life expectancy (a “conduit trust”). If you have a revocable trust do not assume it will work correctly as the beneficiary of your retirement account.

A Standalone Retirement Trust that has specific provisions for administering retirement accounts, and that is separate and distinct from your revocable living trust (that has been drafted to address the entire gamut of your non-retirement assets), is the preferable type of IRA trust beneficiary.

We work with our clients, and their advisors, to educate them about the proper way to use trusts as beneficiaries of retirement plan assets. For many clients with significant retirement assets we the use of a stand-alone retirement plan trust that will provide many benefits to their loved ones as beneficiaries.

Properly drafted, this type of trust offers the following advantages:

  • Protects the inherited IRA from each beneficiary’s creditors as well as predators and lawsuits
  • Insures that the inherited IRA remains in the family bloodlines and out of the hands of a beneficiary’s spouse, or soon-to-be ex-spouse
  • Allows for experienced investment management and oversight of the IRA assets by a professional trustee
  • Prevents the beneficiary from gambling away the inherited IRA or blowing it all on exotic vacations, expensive jewelry, designer shoes and fast cars
  • Enables proper planning for a special needs beneficiary
  • Permits minor beneficiaries, such as grandchildren, to be immediate beneficiaries of the inherited IRA without the need for a court-supervised guardianship
  • Facilitates generation-skipping transfer tax planning to insure that estate taxes are minimized or even eliminated at each generation

If you are interested in learning more about this unique estate planning tool contact us to set up a meeting.




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