Blogs > Your Money

Dave Patterson and Erin Preston, a father-daughter team of Certified Financial Planner® licensees, provide thoughts and suggestions on a broad collection of personal finance topics.  Information provided in this BLOG is intended to be of a general nature and may not be appropriate for all situations.  Readers should consult with their own financial advisors before relying on any information contained herein.

Thursday, September 9, 2010

Naming a Trust as Beneficiary of Your IRA

In December 2009 we wrote a blog titled “Don’t Overlook Beneficiary Designations”. We noted in that article that it if you are married and have established revocable living trusts, with your spouse as primary beneficiary, it may make sense to name your trust as a contingent beneficiary. Doing so may allow your spouse to disclaim (refuse) all or a part of the IRA distributions in order to “fund” your trust, should pre-decease your spouse. (Note: “Funding” a trust involves re-titling assets in the name of the trust and or designating the trust as a beneficiary of insurance policies or retirement accounts).

Revocable living trusts can be set up for many reasons, but commonly are used to avoid costly estate taxes. At the present time (2010) there are no estate taxes, since Congress let the estate tax expire at the end of 2009. It is expected that Congress will enact a new estate tax by year-end. If not, estate tax law will revert back to a one million dollar exemption per person with the highest estate tax rate exceeding 50%. We can be quite sure, therefore, that there will be an estate tax in our immediate future.

With properly executed revocable trusts and proper titling of assets, a couple can protect two times the estate tax exemption from estate taxes. With a one million dollar exemption, that would mean a married couple could therefore shelter two million dollars from estate taxes. If, however, the majority of your assets are held in IRA accounts with your spouse as beneficiary, those assets would not be included in the trust. The trust might therefore not be fully funded, resulting in an estate tax liability.

By specifying the trust as a contingent beneficiary, the spouse can disclaim some or all of the IRA funds, if necessary, to fund the trust. While distributions from the IRA might be taxable at the trust’s higher tax rate, estate tax rates are typically much higher than income tax rates. Therefore, significant taxes may be saved by diverting some or all of the IRA to the trust. We highly recommend discussing the tax issues with a CPA prior to disclaiming any benefits.

If an estate tax liability is unlikely and you have children you want to be contingent beneficiaries, it is generally better to actually name them as contingent beneficiaries, even if they are the beneficiaries of the trust. Naming the children as contingent beneficiaries of the IRA will allow the IRA to be split into separate IRAs upon your death so that each child can take distributions over their individual life expectancy. Separate IRAs also provide more individual flexibility with respect to distributions for the children.

If the IRA is paid to the trust as contingent beneficiary, with your children beneficiaries of the trust and certain conditions are met, the distributions may be paid out over the life expectancy of the eldest child. If the trust does not meet those conditions, the IRA will have to be distributed within five years, thereby eliminating the ability to allow the IRA to continue to grow tax-free.

The tax rules involving retirement plans and trusts can be quite complex. We highly recommend you seek the professional advice of a CPA, tax attorney, estate planner or financial advisor, if you have any questions.


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