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The KRASA LAW, Inc. Estate Planning Blog

Friday, April 28, 2017

Trusts as IRA Beneficiaries: Part II


In my last article I discussed the fact that while IRA’s should not be re-titled to your trust during your lifetime, you might want to consider naming a trust as a beneficiary of your IRA upon your death under certain conditions.  I also discussed the paramount importance of making sure that a trust that is to be named as a beneficiary of an IRA is structured in such a way as to qualify as a “Designated Beneficiary” under the IRS rules which will allow the trust beneficiaries to stretch Required Minimum Distributions (“RMDs”) over the oldest trust beneficiary’s life expectancy.  

The rule requiring that the oldest trust beneficiary’s life expectancy be used to calculate RMD’s creates two further issues: (1) How is the “oldest trust beneficiary” determined? (2) Can anything be done to prevent the younger beneficiaries from having to use the oldest trust beneficiary’s life expectancy?

(1)  How is the “Oldest Trust Beneficiary” Determined?

Assume that the Pop Star Trust is named as the 100% beneficiary of an IRA.  The Pop Star Trust names three beneficiaries to inherit the IRA in equal shares: Gwen, Kelly, and Meghan.  Gwen is 47; Kelly is 35; and Meghan is 23.  Assume further that the trust provides that if Gwen dies while still leaving a portion of her IRA, then the remaining balance of her share shall be distributed to Bing who is 74.  

In legal terms, Gwen, Kelly, and Meghan are considered “current beneficiaries” while Bing is considered a “contingent” beneficiary.  Who is the “oldest” trust beneficiary?  Is it Gwen, the oldest current beneficiary, or is it Bing?  This is a critical question because Gwen’s longer life expectancy would allow more tax deferred growth and tax savings than Bing’s shorter life expectancy.  Fortunately the IRS has some guidance on this issue.

If the Pop Star Trust is designed as a “conduit trust,” meaning that the RMD’s must be distributed out of the trust and to the individual beneficiaries, then you only need to consider the ages of the current beneficiaries and not the contingent beneficiaries.  With regard to a “conduit trust,” Gwen would be considered the oldest trust beneficiary and not Bing.

Although the conduit provisions make it much easier to determine the “oldest” beneficiary, it could be less than ideal to force the RMD’s out of the trust and to the individual beneficiaries.  You might have concern about the beneficiary’s ability to manage his or her inheritance or the beneficiary might have special needs and the receipt of the RMD’s might make the beneficiary ineligible for public benefits.  As a result, an “accumulation” trust might be preferred.

If the trust is designed as an “accumulation trust,” then the trustee is not forced to distribute RMD’s out of the trust and to the beneficiary directly.  The RMD’s that are taken out of the IRA can therefore “accumulate” in the trust and be distributed over a much longer timeframe at the discretion of the trustee.  However, if the trust is structured as an “accumulation trust,” then contingent beneficiaries must be considered when determining who is the “oldest” trust beneficiary.  With regard to an “accumulation trust,” Bing would be considered the oldest trust beneficiary and not Gwen.

One way to draft around this problem would be to make sure that in no case can a beneficiary older than Gwen be considered a beneficiary of the trust.  Even if you do not name a specific beneficiary who is older than Gwen, it is likely that you will name trust-maker’s natural heirs as remote contingent beneficiaries.  Depending upon the circumstances, it is possible that a natural heir could end up being younger than Gwen.  To be safe, specific language should be included to state that anybody who was born before Gwen shall be considered to be deceased for purposes of the trust, ensuring that Gwen – and not a contingent beneficiary – should be considered the oldest trust beneficiary.     

(2) Can anything be done to prevent the younger beneficiaries from having to use the oldest trust beneficiary’s life expectancy?

If the Pop Star Trust is named as the beneficiary of an IRA and is structured as a “conduit trust,” or is structured as an “accumulation trust” but has specific language that eliminates any contingent beneficiary who was born before the oldest current beneficiary, then Gwen’s life expectancy will be used to calculate RMD’s for all of the trust beneficiaries.  While this is better than using Bing’s life expectancy, it is still a great disadvantage to Meghan and Kelly who are both considerably younger than Gwen.

The ideal situation would be to allow for “separate share treatment”: each beneficiary calculating her RMD’s for her share of the IRA to be based on her own life expectancy.

To achieve this result, instead of naming the Pop Star Trust as the 100% beneficiary on the IRA beneficiary designation form and allowing the trust to divide the IRA into three separate shares, each separate share should be listed directly on the IRA form as follows: 33.4% to the Gwen Trust established under the Pop Star Trust; 33.3% to the Kelly Trust established under the Pop Star Trust; and 33.3% to the Meghan Trust established under the Pop Star Trust.  Although there is rarely enough room on a standard IRA beneficiary designation form to fit in so much text, naming each share separately is critical in order to maximize the tax benefits for each beneficiary.  

KRASA LAW, Inc. is located at 704-D Forest Avenue, Pacific Grove, California 93950 and Kyle may be reached at 831-920-0205.

Disclaimer: This article is for general information only.  Reading this article does not establish an attorney-client relationship.  Before acting upon any of the information presented in this article, you should consult a competent attorney who is licensed to practice law in your community.    


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KRASA LAW assists clients with Estate Planning, Elder Law, Pet Trusts, Asset Protection, Special Needs Planning and Probate / Estate Administration in Pacific Grove, CA(93950), Monterey (93944, 93940, 93943, 93942), Salinas (93901, 93905, 93906, 93907), Hollister (95023,95023) Pebble Beach (93953), Carmel By The Sea (93921), Seaside (93955) and Carmel (93923, 93922) in Monterey County and San Benito California.

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