1. Using Trusts as IRA Beneficiaries
Jeffrey Levine
IRA Technical Consultant
Ed Slott and Company, LLC
Copyright © 2012 Ed Slott and Company, LLC

2. Overview of Beneficiary Rules
IRAs pass by way of beneficiary form
Avoid time and expense of probate
Overrides a beneficiary named in the will (for that IRA only)
In absence of a named beneficiary, the IRA will pass according to the custodial document
Often the owner’s estate
May be owner’s spouse and/or children
Copyright © 2012 Ed Slott and Company, LLC

3. Two Types of IRA Beneficiaries
Designated Beneficiary
Non-Designated Beneficiary
Copyright © 2012 Ed Slott and Company, LLC

4. Two Types of IRA Beneficiaries (Cont.)
IRA Beneficiary
Any person or entity that inherits an IRA
Non-Designated Beneficiary
Estate
Charity
Non See-through Trusts
No stretch IRA
5 Year Rule or
IRA owner’s remaining life expectancy
Copyright © 2012 Ed Slott and Company, LLC

5. Two Types of IRA Beneficiaries (Cont.)
IRA Beneficiary
Any person or entity that inherits an IRA
Designated Beneficiary
A living, breathing person
Has a life expectancy
See-through trusts
Stretch IRA is able to be used
Copyright © 2012 Ed Slott and Company, LLC

6. The Stretch IRA
A term used by practitioners to describe how distributions from some inherited IRAs can be extended over the life expectancy of the beneficiary
Keeps tax-deferral of account intact for as long as possible
Helps minimize impact of income taxes
Copyright © 2012 Ed Slott and Company, LLC

7. The Stretch IRA (Cont.)
Distributions must begin by December 31st of the year following the year of death
All beneficiaries calculate RMDs using the Single Lifetime Table
Beneficiary is always able to take more than the RMD
No credit in current year for amounts taken in excess of RMDs during previous years
Copyright © 2012 Ed Slott and Company, LLC

8. What Happens if There is More Than One Beneficiary?
General Rule
All beneficiaries must take RMDs based on the age of the oldest beneficiary
If one of the beneficiaries is not a designated beneficiary, the stretch is lost for all beneficiaries
Copyright © 2012 Ed Slott and Company, LLC

9. What Happens if There Is More Than One Beneficiary? (Cont.)
Separate Account Rule
Allows each beneficiary to use their own life expectancy
September 30th “cash out” date
Separate accounts must be established by December 31st of year following year of death
Copyright © 2012 Ed Slott and Company, LLC

10. Reasons to Name a Trust as an IRA Beneficiary
The primary reason to name a trust as the beneficiary of an IRA should be some form of control.
Common scenarios where a trust might be considered include:
Situations involving beneficiaries who are
Minors
Disabled
Incompetent
Unsophisticated
Concerns when there is a second marriage
Copyright © 2012 Ed Slott and Company, LLC

11. Reasons to Name a Trust as an IRA Beneficiary (Cont.)
Other common scenarios where a trust might be considered include:
Cases where the owner wants to guarantee the stretch IRA is used
Planning to help avoid federal and/or state estate taxes*
*Can also be done without a trust
Situations where creditor protection may be an issue
Clients who are concerned about beneficiaries’ spouses
Plans that involve the use of charitable trusts
Copyright © 2012 Ed Slott and Company, LLC

12. Reasons NOT to Name a Trust as an IRA Beneficiary
To save money on income taxes
Top federal income tax rate for single and joint filers in 2012 kicks in at income over $388,350
Top federal income tax rate for trusts and estates in 2012 kicks in at income over $11,650
To save money on estate taxes
“Because my attorney told me so”
Copyright © 2012 Ed Slott and Company, LLC

13. See-Through Trusts Also known as look-through trusts
Allow trust beneficiaries to use oldest applicable trust beneficiary’s life expectancy to calculate RMDs
There is no separate account treatment for trust beneficiaries
Must meet certain requirements
Copyright © 2012 Ed Slott and Company, LLC

14. See-Through Trust Requirements
Regulation 1.401(a)(9)-4, A-5
Valid under state law
Irrevocable at death
Trust beneficiaries are identifiable
Proper documentation is provided to the custodian by October 31st of the year following the year of death
Copyright © 2012 Ed Slott and Company, LLC

15. Life Cycle of an IRA Trust
Owner determines there is a post-death control issue that requires the use of a trust
Trust is drafted by a qualified estate planning attorney (can be a testamentary trust)
The trust is named as the beneficiary on the beneficiary form
John Doe IRA trust
John Doe IRA trust established under Article X Section X of John Doe Last Will and Testament
Copyright © 2012 Ed Slott and Company, LLC

16. Life Cycle of an IRA Trust (Cont.)
IRA Owner Dies
Properly titled inherited IRA is established FBO the trust
John Smith (deceased January 3, 2010) IRA fbo John Smith Trust
Distributions go from the inherited IRA to the trust
Distributions go from the trust to the trust beneficiaries per the terms of the trust
Copyright © 2012 Ed Slott and Company, LLC

17. Life Cycle of an IRA Trust (Cont.)
Trust Beneficiary
Trust
Trust Distributions
Trust Distributions
Trust Beneficiary
IRA Distributions Including RMDs
Inherited
IRA
Trust Distributions
Trust Beneficiary
Copyright © 2012 Ed Slott and Company, LLC

18. Conduit Trusts Discretionary Trusts Two Types of IRA Trusts
Also known as accumulation trusts
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19. Conduit Trusts
No less than the RMD is required to be distributed to the trust beneficiaries each year
Trust beneficiaries pay income tax on RMDs at their own personal rates
Only income beneficiaries of the trust are looked at to consider oldest age for RMDs
Copyright © 2012 Ed Slott and Company, LLC

20. Conduit Trusts (Cont.) Advantages of conduit trusts include:
Potentially more tax efficient than discretionary trusts
Any remainder beneficiary can be used without ruining the stretch IRA
Disadvantages of conduit trusts include:
Less post-death control
Copyright © 2012 Ed Slott and Company, LLC

21. Discretionary Trusts
RMDs from the inherited IRA may be accumulated in the trust
RMDs may also be distributed out of the trust, depending on the language of the trust
Distributions from an inherited IRA not passed along to trust beneficiaries within the same year are taxed at trust tax rates
Funds distributed from a trust to a beneficiary during the first 65 days of the year can be treated as distributed in the prior year if the trustee elects
All current and potential beneficiaries of the trust are looked at to consider oldest age for RMDs
Current beneficiaries
Remaindermen
Copyright © 2012 Ed Slott and Company, LLC

22. Discretionary Trusts (Cont.)
Advantages of discretionary trusts include:
Greater control over trust assets
Easier to keep assets away from:
Creditors
Ex-spouses
Disadvantages of discretionary trusts include:
Greater possibility for conflict between trustee and trust beneficiaries
Distributions may be taxed at compressed trust tax brackets
Non-designated remaindermen beneficiaries will cause stretch to be blown
Copyright © 2012 Ed Slott and Company, LLC

23. Discretionary Trusts (Cont.)
Discretionary Trust Idea:
Consider Roth conversions during owner’s lifetime
Inherited IRAs cannot be converted to inherited Roth IRAs
Inherited plans (e.g. inherited 401(k)) can be converted to inherited Roth IRAs
Inherited Roth IRAs can generally avoid the tax issues that are present with traditional IRAs
Copyright © 2012 Ed Slott and Company, LLC

24. When Does it All End? When there is no money left in the inherited IRA
When the trust terminates
When there is $X or less in the trust
After X years
When the beneficiary is X years old
When X dies
Check with the custodian to see if the trust assets can be assigned out to the trust beneficiaries if the trust terminates, but there are still funds in the inherited IRA
Copyright © 2012 Ed Slott and Company, LLC

25. 5 Costly IRA Trust Mistakes
Moving an IRA “into” the trust
Trust language that calls for debts and expenses of the estate to be paid from trust assets
Not understanding what constitutes trust income
Naming a trust as an IRA beneficiary without first considering alternatives
Failing to add flexibility to the overall plan
Copyright © 2012 Ed Slott and Company, LLC

26. Mistake #1- Moving an IRA “Into” the Trust
IRAs/Inherited IRAs cannot be moved into trusts
Causes the IRA/inherited IRA to be taxable
IRAs cannot be owned by trusts during an owner’s lifetime
A common mistake occurs when clients try to fund revocable living trusts with IRA assets
For owners, the mistake can only be fixed if caught within 60 days
If this mistake is made by a beneficiary, the mistake cannot be fixed
Copyright © 2012 Ed Slott and Company, LLC

27. Mistake #2- Trust language that calls for debts and expenses of the estate to be paid from trust assets
Estate is treated as a beneficiary of IRA
An estate is not a designated beneficiary
Stretch IRA can be blown
Creditor protection of the inherited IRA may be compromised
To remove an estate as a trust beneficiary, cash out the estate (pay off estate obligations) by September 30th of the year following the year of death
PLRs , ,
“Shall” vs. “may” vs. staying silent
Trust expenses vs. estate expenses
Copyright © 2012 Ed Slott and Company, LLC

28. Mistake #3 - Not Understanding What Constitutes Trust Income
Inherited IRA distributions; What’s income? What’s principal?
Uniform Principle and Income Act (UPAIA)
Adopted by over 40 states
Defines 10% of RMD as income, 90% principal
Income using the Unitrust concept
Must be allowed by state law
Federal regulations allow for unitrust rate to be set between 3% and 5%
Check to see if trust uses the term “income” or “RMDs”
An attorney can use specific language to draft around income issues
Copyright © 2012 Ed Slott and Company, LLC

29. Mistake #3 - Not Understanding What Constitutes Trust Income (Cont.)
QTIP trusts as IRA beneficiaries
Revenue Ruling
Surviving spouse is entitled to trust income during their lifetime
After surviving spouse’s death, the trust’s principal passes to beneficiaries named by original IRA owner
Allows marital deduction to be used
Copyright © 2012 Ed Slott and Company, LLC

30. Mistake #3 - Not Understanding What Constitutes Trust Income (Cont.)
QTIP trusts create unique problems for IRAs
QTIP trusts must use the word “income”
Remainder beneficiaries may not inherit any assets for many years
Inherited IRA might be completely exhausted prior to remainder beneficiaries inheriting assets
Copyright © 2012 Ed Slott and Company, LLC

31. Mistake #4 - Naming a Trust as an IRA Beneficiary Without First Considering Alternatives
Is an UGMA/UTMA account sufficient for minor beneficiaries
Beneficiary will have access to funds at 18 or 21
“Jim Smith as custodian for John Doe, under the State X Uniform Transfers to Minors Act”
Can disclaimer planning be used to avoid estate taxes?
QTIP trusts
Can the IRA be split between the surviving spouse and the children?
Can life insurance be used to provide a benefit to the surviving spouse and/or other beneficiaries?
Copyright © 2012 Ed Slott and Company, LLC

32. Mistake #5 – Failing to Keep the Plan Up to Date
Is a trust still needed as beneficiary?
Is the beneficiary still a minor?
Is creditor protection still an issue?
Are there enough other assets to fund the credit shelter trust?
Have trust beneficiaries predeceased the owner?
Has the trust been named on the beneficiary form for any new accounts opened?
Do all IRA custodians allow for trusts as IRA beneficiaries?
Copyright © 2012 Ed Slott and Company, LLC

33. Recent Rulings and Updates
PLRs , and
No separate account treatment for trust that splits into subtrusts
PLR
Separate account treatment when subtrusts are named as the beneficiaries
“Subtrust X established under Article X, Section X of the John Doe IRA Trust”
PLRs , ,
No separate account treatment when primary trust is named beneficiary
Copyright © 2012 Ed Slott and Company, LLC

34. Recent Rulings and Updates (Cont.)
PLR
IRS allowed a disabled beneficiary to transfer an inherited IRA to special needs trust (of which they were the beneficiary)
Inherited IRA still not moved into trust
Properly titled inherited IRA FBO special needs trust established
Distributions from inherited IRA payable to special needs trust
Considered a 1st party trust
Entitlement programs reimbursed after death of beneficiary before any remaining assets can pass to remaindermen
IRS reiterated that such a transfer cannot occur during an IRA owner’s lifetime
Followed previous IRS decisions in:
PLR
PLR (minor beneficiary)
Copyright © 2012 Ed Slott and Company, LLC

35. Recent Rulings and Updates (Cont.)
PLR
A trust was named as the beneficiary of each account
Financial advisor incorrectly told client that the entire IRA/Roth IRA had to be distributed to the trust
An extension of the 60-day rollover window was granted and the spouse was allowed to rollover three traditional IRAs and a Roth IRA to her own IRA and Roth IRA
Spouse had “total control over the disposition of said IRAs”
Copyright © 2012 Ed Slott and Company, LLC

36. Recent Rulings and Updates (Cont.)
PLR
Numerous other PLRs have been granted for similar requests
Spouse must have complete “dominion and control”
To avoid these situations, consider naming
The trust as the IRA’s primary beneficiary and the spouse as the contingent beneficiary or
The spouse as the IRA’s primary beneficiary and the trust as the contingent beneficiary
Copyright © 2012 Ed Slott and Company, LLC

37. Recent Rulings and Updates (Cont.)
PLR
IRS denied spousal rollover of IRA left to trust
Spouse was sole trustee and was able to take distributions from the trust for her health, maintenance and support
Remaining principal was to pass to couple’s son
Ruling was denied because spouse did not have complete and total control over inherited IRA
Distributions were subject to “ascertainable standards”
Copyright © 2012 Ed Slott and Company, LLC

38. Recent Rulings and Updates (Cont.)
PLR
Landmark ruling allowing community property to be rolled over by surviving spouse even though trust was partial IRA beneficiary
Trust divided into several subtrusts, with spouse having total access to assets in “Marital Share One”
Trustee had full discretion to divide trust property using non-pro- rata allocation
Trustee exchanged decedent’s IRA with spouse’s property of equal value such that Marital Share One held entire IRA
Copyright © 2012 Ed Slott and Company, LLC

39. Recent Rulings and Updates (Cont.)
PLR
Trust was beneficiary of decedent’s IRA
Trust created separate 1/3 share for decedent’s surviving spouse and left remaining 2/3 to decedent’s surviving children
There were 2 surviving children
Spouse was able to rollover her share to an inherited IRA
The decedent’s children were able to make trustee-to-trustee transfers of their separate trust shares of the inherited IRA to separate inherited IRAs benefiting the trust
RMDs still needed to be determined using surviving spouse’s life expectancy
Copyright © 2012 Ed Slott and Company, LLC

40. Your Immediate Action Plan
Review the IRA trust rules as soon as possible to reinforce what we’ve covered today
Make a list of clients who have named trusts as their IRA beneficiary
Review their situation and see if a trust should, in fact, be named as the beneficiary
Make a list of clients who may want to consider naming a trust as an IRA beneficiary

41. Your Immediate Action Plan
Learn the rules that apply in your state
Age of majority
Definition(s) of income
IRA creditor protections
Find a qualified estate planning attorney, who also has knowledge about IRA rules, that you can feel confident in recommending to clients

42. www.IRAhelp.com THANK YOU!!! For more information about Ed Slott
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