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Plain Vanilla. The default beneficiary designation, especially now that the Minimum Required Distribution
(MRD) regulations have been simplified, is the spouse as primary beneficiary, with the children named as
secondary or contingent beneficiaries. A married plan owner/participant gets to use the new extended MRD
Tables, and a surviving spouse gets to take control of the whole plan account by rolling it into her own IRA,
with the ability to name new beneficiaries.
Why Name a Trust as Beneficiary? There are typically three principal reasons why an estate planner or
advisor would recommend a trust as primary beneficiary (we often recommend a trust as contingent
beneficiary):
1. When there is a need to use up all or part of the estate tax exemption.
2. When there is a desire to protect the assets from unrestricted access by heirs, because of a desire to delay
distributions, to fund retirement, or spousal or creditor problems.
3. When there is a disabled beneficiary, and the desires to have plan benefits available for supplemental
needs, but not disqualify the beneficiary from government assistance such as Medicaid.
What is the Effect of Naming a Trust as Beneficiary? Naming a trust as beneficiary will probably effect the
timing and rate of MRD’s from the plan. Of course, MRD’s trigger income tax which is a bad word, to say
nothing of the being a pain in pocketbook. While everyone realizes that income tax is payable on monies
withdrawn from the plan, it is a fact of life that most of us choose not to think about when we look at our plan
balances. The fact of life is, therefore, that it is only the after tax portion of the plan assets that the beneficiary
can spend, no matter when the money is withdrawn.
So the bottom line is that naming a trust as beneficiary might be a trade-off for estate tax benefits, or control
over assets, as the positive aspects, with some loss of deferral potential as the negative. If there is some
loss of deferral potential, the client wants to know how the deferral will be determined and has the trust
avoided the necessity of the mandatory withdrawal of plan assets within five years of the participant’s death.
This is where the rules get complicated and have been subject to recent shifts in the IRS position. The first
question is whether the trust qualifies as a "designated beneficiary". Without quoting the chapter and verse of
the regulations, basically, a trust will qualify as a designated beneficiary if all the trust beneficiaries are
individuals as of October 31 of the year following the participant’s death. (The IRS provided a window so that a
charitable beneficiary, if named in the trust, can be paid off before that October 31deadline, leaving only
individual beneficiaries.
If the trust satisfies the requirements as a "designated beneficiary", the general rule is that the trustee can
withdraw funds over the life expectancy of the oldest beneficiary. If the oldest beneficiary is the spouse, then
MRD’s would be larger if the oldest beneficiary is one of the children. If no spouse is involved, the drafters
challenge might be to create separate trusts for each child so that each child would have his or her own life
expectancy to use in calculating the MRD. This may or may not be important, depending on the family
circumstances, how close the children are to each in age, and who is the trustee, responsible for controlling
withdrawals from the plan.
Conduit Trusts and Income Taxes. When trusts are named as beneficiaries, we typically provide that the trust
shall act as a conduit, distributing to individual beneficiaries all MRD’s. Accumulating taxable income in the
trust under current law is expensive, as the trust will usually be in the highest personal income tax bracket. If
the beneficiaries themselves are also in the highest bracket, nothing is lost. However, often the individual
beneficiaries are in a lower bracket so distribution of the MRD is desirable to put the taxable income on the
individual’s return at lower rates.
Disabled Beneficiaries. If there are disabled beneficiaries, including a spouse, the trust as beneficiary can
avoid losing eligibility for government benefits such as Medicaid or disability income, or in many cases, both.
Here the drafting gets tricky because one is dealing with income tax considerations, sometimes estate taxes
and, of course, income taxes on plan distributions.
Conclusion. This isn’t a perfect world. There are often trade-offs in planning. Maximum deferral of income
taxes on retirement accounts may not be desirable for some of the reasons outlined above. Control over plan
assets and integration with an overall estate plan may be more important. Given those considerations, the
planner’s challenge is to avoid the requirement of immediate distributions (five years) and provide the best
deferral option (stretch) that fits the overall objectives. If you have clients with large IRA or other retirement
accounts and challenging estate planning considerations, call Jim Modrall at 941-9660. There is no charge
for the initial consultation.
©BRANDT, FISHER, ALWARD & ROY, P.C.
This newsletter is provided for informational purposes and should not be acted upon without professional
advice.
| WEALTH CONSERVATION: PROFESSIONAL ALERT Brandt, Fisher, Alward & Roy, P.C. |
| December 2003 IRA’s - TRUSTS AS BENEFICIARIES by James R. Modrall III, J.D., C.P.A. |
| If you would like to receive future editions of the monthly Wealth Conservation Newsletter directly to your e-mail account, please e-mail our office using the following link: Estate Planning Newsletter |
| Brandt, Fisher, Alward & Roy, P.C. Attorneys at Law |