IRA Trusts – What happens when your IRA outlives you?
Clients want to protect their IRAs and other qualified retirement plan assets for their families, but don’t really understand what happens to these assets after they die. Without proper planning, these assets can be exposed to beneficiaries’ creditors and other beneficiary associated risks. By using specially designed IRA trusts, these assets can be protected from creditors, predators and achieve maximum tax deferral.
Income Tax Risks and the Benefit of Tax Deferral
Except for a Roth IRA, income taxes become due on IRAs whenever assets are withdrawn. The top federal rate is now 39.5%, and many states have taxes as well. There is an exception to this rule that allows a “tax free rollover” into a surviving spouse’s individual IRA at the death of the first spouse.
IRAs and other retirement accounts can offer tax deferral benefits for non-spouse beneficiaries after the owner’s death as well. This tax deferral is called “stretching” the IRA. Stretching an IRA allows the beneficiary to withdraw money from the IRA over the course of his or her life expectancy, as opposed to taking it all in one lump sum.
By stretching the distributions from an IRA over a longer period of time, sometimes 20-30 years or more, taxes are deferred. Additionally, this stretch means that the IRA may actually appreciate in value for the first few years as only a percentage is being taken out by the beneficiary each year, as opposed to a much larger chunk at the time of the inheritance.
Asset Protection and Government Benefits Issues with Inherited IRAs
Qualified retirement plans such as traditional IRAs are protected from creditors under ERISA, but Roth IRAs and inherited IRAs are generally exposed. This could mean that shortly after an inheritance, one of the intended beneficiary’s creditors could become the actual beneficiary of your IRA.
In the context of a divorce, an inherited IRA is on the table because it can be transferred by order of the Court. This could have the effect of having a beneficiary’s IRA inheritance later divided by half or more.
What about if a beneficiary has an accident or disability and is receiving Medicaid, SSI or certain types of Veterans benefits? Any inheritance, including assets in an IRA, are considered “resources” and could impact these means tested government benefits. Any receipt of an inheritance over could jeopardize these benefits.
The Benefits of the IRA Trust
Planning with trusts for the distribution of an IRA or other qualified retirement account can give beneficiaries asset protection, divorce protection, special needs and government benefits protection, and solid estate planning. IRA Trusts must meet several tests in order to qualify as a designated beneficiary of an IRA or retirement plan account. A basic Revocable Living Trust generally will not satisfy the provisions needed to be considered an IRA Trust. As such, it may make sense to establish a separate IRA trust for these special assets.
Establishing a separate IRA Trust as your IRA or retirement plan beneficiary is generally preferable to naming beneficiaries outright. IRA Trusts can ensure that a client’s goals are carried out, with the maximum “stretch” tax deferral accomplished.
Planning with trusts can give beneficiaries asset protection, divorce protection, special needs and government benefits protection, and solid estate planning. Every situation is different, and it is only with the input of a qualified estate planning attorney and your other trusted advisors that your goals will be accomplished.
Call today for an appointment. Quinn Estate & Elder Law will help you discover the proper mix of estate planning and trust vehicles for your situation.
Written by Brian G. Quinn, Attorney with Quinn Estate & Elder Law