|The Best Fit for a Trus­teed IRA

Here’s what ad­vis­ers should know about this in­creas­ingly avail­able op­tion so they can help clients make the most suit­able choice.

Financial Planning - - CONTENT - By Ed Slott

Here’s what ad­vis­ers should know about this in­creas­ingly avail­able op­tion so they can help clients make the most suit­able choice.

A TRUS­TEED IRA OF­FERS PRO­VI­SIONS BE­YOND A cus­to­dial plan, but is it a good strat­egy for clients? That an­swer de­pends on sev­eral fac­tors, in­clud­ing how much con­trol — or not — clients wants their ben­e­fi­cia­ries to have.

Un­der the tax code, an IRA can be es­tab­lished as a trust or cus­to­dial ac­count. With a trus­teed IRA, a fi­nan­cial or­ga­ni­za­tion adds trust terms and lan­guage to the plan. Thus, the IRA it­self be­comes a trust, with the fi­nan­cial or­ga­ni­za­tion act­ing as the trus­tee.

The ac­count is then ad­min­is­tered un­der the trust pro­vi­sions both be­fore and af­ter the IRA owner’s death. In gen­eral, this will mean greater con­trol for the IRA owner and less for the ben­e­fi­cia­ries.

As a trus­teed IRA is, in essence, a con­duit trust; the trus­tee must pay out the an­nual re­quired min­i­mum dis­tri­bu­tions to ben­e­fi­cia­ries. In ad­di­tion to en­sur­ing the stretch IRA for ben­e­fi­cia­ries, some trus­teed IRAS al­low dis­tri­bu­tions be­yond the RMDS for health, ed­u­ca­tion and other sup­port. How­ever, be­cause trus­teed IRAS are stan­dard­ized doc­u­ments, there will likely be some lim­its on the post-death con­trol op­tions.

THE COST OF CON­TROL

Clients who have large IRAS as well as other ex­ten­sive as­sets will prob­a­bly al­ready be us­ing trusts as part of their over­all es­tate plan­ning strat­egy. For those clients, costs are not a con­cern and they would likely be best-served by nam­ing a trust as their IRA ben­e­fi­ciary.

For other clients, whose IRA is their largest as­set by far, a trus­teed IRA may make sense. A trus­teed IRA will gen­er­ally cost less than hir­ing an at­tor­ney to draft a trust. How­ever, there will still be a set-up fee, as well as on­go­ing fees.

One ad­van­tage of a trus­teed IRA is that, if the IRA owner be­comes in­ca­pac­i­tated, trus­teed IRAS of­ten have a pro­vi­sion that al­lows the trus­tee to take the RMD on their be­half.

This would not be pos­si­ble with a trust or an in­di­vid­ual named on the IRA’S ben­e­fi­ciary des­ig­na­tion form. In those cases, a power of at­tor­ney would likely be needed to get the RMD paid out. A trus­teed IRA elim­i­nates this com­pli­ca­tion. The trus­tee can also make life­time in­vest­ment de­ci­sions, as well as pay any Ira-re­lated fees or ex­penses.

EN­SUR­ING THE STRETCH FOR BEN­E­FI­CIA­RIES

Trus­teed IRAS usu­ally in­clude pro­vi­sions lim­it­ing how much free­dom a ben­e­fi­ciary has re­gard­ing how much they can take from the in­her­ited IRA.

A trus­teed IRA may be a good strat­egy for clients whose pri­mary con­cern is pre­serv­ing the stretch for their ben­e­fi­cia­ries. The trus­teed IRA may limit yearly dis­tri­bu­tions to the amount of the RMD, pre­serv­ing the stretch IRA.

If, in­stead, a trust is named as the ben­e­fi­ciary of an IRA and the trust meets the look-through rules, the ben­e­fi­ciary of the trust can use the stretch and take RMDS over the life ex­pectancy of the old­est trust ben­e­fi­ciary.

How­ever, there is a risk that re­quire­ments of the look­through rules may not be met by a par­tic­u­lar trust. An at­tor­ney draft­ing a trust may make an er­ror that causes the trust to not meet these re­quire­ments, with the re­sult­ing loss of

the stretch for ben­e­fi­cia­ries. Go­ing with a trus­teed IRA mit­i­gates this risk.

MUL­TI­PLE BEN­E­FI­CIA­RIES

Even if a trust is drafted in such a way as to meet the re­quire­ments of the look-through rules, there can still be prob­lems with achiev­ing the max­i­mum stretch if there are mul­ti­ple trust ben­e­fi­cia­ries.

The sep­a­rate ac­count rules for mul­ti­ple ben­e­fi­cia­ries do not ap­ply to trusts. This means that all trust ben­e­fi­cia­ries must honor the ben­e­fi­ciary with the short­est life ex­pectancy.

This may not mat­ter so much if the ben­e­fi­cia­ries are close in age. How­ever, if ben­e­fi­cia­ries in­clude a sur­viv­ing spouse as well as chil­dren, this se­verely lim­its the stretch avail­able for the chil­dren.

The work-around for this prob­lem is to cre­ate and name sub-trusts for each ben­e­fi­ciary di­rectly on the IRA ben­e­fi­ciary des­ig­na­tion form. This for­mat al­lows each trust ben­e­fi­ciary to use their own life ex­pectancy.

Us­ing a trus­teed IRA elim­i­nates this com­pli­ca­tion, be­cause they are gen­er­ally drafted in such a way as to en­sure each ben­e­fi­ciary may use their own life ex­pectancy.

SUC­CES­SOR BEN­E­FI­CIA­RIES

When an IRA owner names a ben­e­fi­ciary out­right, the owner will have no say in what hap­pens to the funds af­ter the death of the ben­e­fi­ciary. A ben­e­fi­ciary may choose their own suc­ces­sor ben­e­fi­ciary.

A trus­teed IRA would give the IRA owner the abil­ity to name suc­ces­sor ben­e­fi­cia­ries. This may be help­ful in sec­ond-mar­riage sit­u­a­tions in which the IRA owner would like to pro­vide for a spouse dur­ing their life­time but then en­sure that the IRA funds go to chil­dren from a prior mar­riage.

This could also be achieved by nam­ing a trust as the IRA ben­e­fi­ciary, although at greater ex­pense.

SPOUSAL ROLLOVER

In many cases, af­ter the death of the IRA owner, a sur­viv­ing spouse will want to do a spousal rollover. This op­tion is avail­able if the spouse is named di­rectly as the sole ben­e­fi­ciary on the ben­e­fi­ciary des­ig­na­tion form.

Fre­quently, when a trust is named as the IRA ben­e­fi­ciary, this op­tion be­comes more com­pli­cated, and some­times re­quires the time and ex­pense of re­quest­ing a pri­vatelet­ter rul­ing from the IRS. There have been many PLRS al­low­ing a spousal rollover when the spouse is the trus­tee of the trust, is the sole ben­e­fi­ciary and has com­plete con­trol over the trust as­sets.

A spousal rollover would likely not be pos­si­ble with a trus­teed IRA, how­ever. Clients who are look­ing for the abil­ity of a sur­viv­ing spouse to do a spousal rollover should strongly con­sider sim­ply nam­ing that spouse on the ben­e­fi­ciary des­ig­na­tion form. They would not be well-served by ei­ther a trust as ben­e­fi­ciary or a trus­teed IRA.

Some clients may have con­cerns about cred­i­tor pro­tec­tion of IRA as­sets for their heirs. For ex­am­ple, a par­ent might be con­cerned that, if a child is hav­ing fi­nan­cial

A trus­teed IRA would give an IRA owner the abil­ity to name suc­ces­sor ben­e­fi­cia­ries.

trou­ble, cred­i­tors could ac­cess the in­her­ited IRA funds.

There are good rea­sons for this con­cern. In Clark vs. Rameker, for ex­am­ple, the U.S. Supreme Court ruled that in­her­ited IRAS are not pro­tected in bank­ruptcy.

A trus­teed IRA would of­fer a higher level of pro­tec­tion from cred­i­tors than leav­ing as­sets out­right to a ben­e­fi­ciary. How­ever, the pro­tec­tion would be lim­ited by the fact that the trus­teed IRA would be re­quired to pay out the RMDS each year to the ben­e­fi­ciary. There would be no way to pro­tect those RMD funds.

By nam­ing a trust as the IRA ben­e­fi­ciary, a higher level of pro­tec­tion could be achieved, be­cause a trust could be drafted to give the trus­tee dis­cre­tion to keep the RMDS in the trust in­stead of pay­ing them out to the trust ben­e­fi­cia­ries.

Of course, there is a down­side to us­ing a trust to pro­tect the RMDS from cred­i­tors. RMD funds held in the trust will be taxed at trust tax rates, which quickly reach the top 39.6% in­come tax bracket. A Roth IRA left to a trust could elim­i­nate this trust tax prob­lem.

Clients who are con­sid­er­ing trusts of­ten want to ap­point an in­di­vid­ual, usu­ally a fam­ily mem­ber, as a trus­tee. Fre­quently, the in­di­vid­ual may be a co-trus­tee with a fi­nan­cial or­ga­ni­za­tion.

This will not work with a trus­teed IRA be­cause for two rea­sons:

1) The trus­tee will be the fi­nan­cial or­ga­ni­za­tion of­fer­ing the trus­teed IRA.

2) The tax code does not per­mit an in­di­vid­ual to be a trus­tee of an IRA.

One big down­side for trus­teed IRAS is the lack of abil­ity to move the in­her­ited IRA as­sets. While there is no rea­son that a trus­teed IRA could not al­low the move­ment of

By nam­ing a trust as an IRA ben­e­fi­ciary, a higher level of pro­tec­tion could be achieved be­cause a trust could be drafted to give the trus­tee dis­cre­tion to keep the RMDS in the trust.

Ed Slott, a CPA in Rockville Cen­tre, New York, is a Fi­nan­cial Plan­ning con­tribut­ing writer and an IRA dis­tri­bu­tion ex­pert, pro­fes­sional speaker and au­thor of sev­eral books on IRAS. Fol­low him on Twit­ter at @thes­lot­tre­port.

in­her­ited IRA funds af­ter the death of the IRA owner, these doc­u­ments are gen­er­ally drafted in such a way that, if not out­right pro­hib­ited, it is cer­tainly not guar­an­teed.

This would be some­thing for clients to se­ri­ously con­sider, be­cause these ac­counts will be in ex­is­tence for many years. Even if the in­sti­tu­tion is sound, if ben­e­fi­cia­ries feel they are get­ting poor ser­vice or would pre­fer dif­fer­ent in­vest­ment choices, they may not be able to vote with their feet.

Trus­teed IRAS are not for ev­ery­one. Con­sider the al­ter­na­tives of sim­ply nam­ing a ben­e­fi­ciary di­rectly on the IRA ben­e­fi­ciary form or nam­ing a trust that has been drafted specif­i­cally for the client by a knowl­edge­able at­tor­ney.

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