For the majority of Americans, most net worth is held in the home and/or tax deferred retirement accounts. Estate planning for the home was covered in our previous post, http://www.perlalaw.com/blog/estate-planning-for-your-home-simple-will-transfer-on-death-affidavit-or-revocable-trust/. This post will focus on planning for tax deferred retirement accounts.
What is a Tax Deferred Retirement Account?
A tax deferred retirement account is a financial account where your contributions can grow tax deferred until they are withdrawn. Traditional IRAs, Annuities and 401(k)’s can all be tax deferred.
Financial institutions all have their own forms and rules for designated a beneficiary of a retirement account. It is essential that you contact your financial institution to ensure that you follow the rules and complete the forms correctly so that your wishes are carried out. Without a properly completed beneficiary designation, the account will transfer by way of the rules of the financial institution, your Last Will and Testament or your state’s inheritance laws.
Naming a Beneficiary
A non-spouse beneficiary has two options once she inherits an IRA or other tax deferred retirement account. First, she can have the value of the IRA distributed to her as a lump sum. If she chooses this first option, she will have to pay income tax on the full value of the distribution she receives. This can bump her into a higher tax bracket and result in a significant income tax liability.
Second, she can retitle the IRA in the name of the deceased IRA owner for the benefit of herself. The IRA will continue to grow tax deferred. She must begin to take required minimum distributions beginning December 31st of the year following the year of the death of the previous owner.
A spouse has an additional option. She can roll over an inherited deferred tax retirement account into her own IRA or other tax deferred plan. She may delay taking minimum distributions until she reaches the age of 70 ½. This can be advantageous if the spouse wishes to delay distributions until she is in a lower tax bracket.
As long as it is permitted by the financial institution, an owner of an IRA can name multiple beneficiaries and upon death, the IRA will be split into separate IRAs for each of the beneficiaries.
Naming a Trust
Under IRS rules, if one names a trust as a beneficiary of an IRA, the beneficiaries of the trust will be treated as having been designated beneficiaries for determining minimum required distributions after the owner’s death if it meets four requirements.
The trust must be valid under state law. It must be irrevocable or become irrevocable upon the owner’s death. The beneficiaries of the trust must be identifiable from the trust instrument, and the trustee must provide the IRA custodian or trustee with the documents required by the custodian or trustee of the IRA by October 31 of the year following the year of the owner’s death.
Hence, a trust can be named as a beneficiary of an IRA and the beneficiaries receive the tax benefits of beneficiary designations as long as the aforesaid requirements are met.
Why Choose a Trust over Individual Beneficiary Designations?
The Supreme Court ruled that an inherited IRA is not eligible for bankruptcy protection. Hence, if you are concerned about creditor protection for your heirs, then a trust may be a better option. It may also be a better option if the intended heir is not responsible with money or you would like the funds used for a particular purpose. In addition, if your heirs are minors or disabled, a trust may be a preferred method to control distributions or protect government benefits.
For more information on Estate Planning for Tax Deferred Retirement Accounts, speak to a Cleveland Estate Planning lawyer.