As more "baby boomers" are retiring and rolling over large
401(k) and other retirement plans to IRAs, proper tax and estate planning for IRAs have become increasingly important.
When an IRA owner becomes age 70 1/2, he or she must soon begin to take
required minimum withdrawals ("RMDs") and pay federal and state income taxes on those withdrawals at his or her
highest rate brackets (unless the IRA is a "Roth", in which case the withdrawals may be income tax free).
Effective January 1, 2003, the IRS changed its RMD rules, allowing a
non-spouse beneficiary (for example, a child) to take or "stretchout" the taxable RMDs over a much longer period,
using his or her own life expectancy rather than the shorter life expectancy of the original IRA owner (the parent). This
means that money inside an inherited IRA may now compound much longer, tax-deferred.
For example, let's take a child age 45 (at the time of his parent's death) who inherits a $200,000 IRA and
withdraws only RMDs. If the IRA grows, from both income and principal appreciation, at the rate of 6% a year, then 30 years
later when the child is age 75, the child will have taken over $400,000 in RMDs and still have almost $300,000 left in the
IRA to use over his or her later years or pass down to his or her children (the original IRA owner's grandchildren).
To sum it up, the original $200,000 inherited IRA became worth over
$700,000 to that family! (And that doesn't include the future value of the RMDs if they're placed into an investment account.)
If we assume the IRA will be worth over $200,000 when the owner passes, or will earn a higher rate of annual return, or will
go to a younger beneficiary, that IRA may eventually be worth well over $1 Million!
In other words, IRAs may now be a huge part of a family's financial future, perhaps for generations - - and
now large IRAs require a higher level of tax and estate planning - - which you can be well-positioned to provide before your
This New IRA Tax "Stretchout" is Not Automatic!
IRA owners and their professional advisors “assume” that the IRA beneficiaries will make the right “stretchout”
decisions, or at least seek the advisor’s help before they take withdrawals. Unfortunately, we have found, after handling
thousands of estates, this is often not the case when the IRA owner dies.
The beneficiaries are not prohibited from withdrawing more than the RMDs and may instead decide to cash out
the IRA earlier than required, blowing the stretchout. This happens because beneficiaries are:
aware of the RMD rules and their choices.
- See themselves listed as beneficiaries
on an account and immediately transfer it into their own names.
- Go to the custodian
asking what to do, are given a check and then immediately cash and deposit it in their own accounts.
- Do what they think (wrongly) is a tax-free rollover to their own IRAs. Just can't wait to get their hands
on the IRA money or are influenced by a spouse or some other third-party to grab and spend it!
Yanking the IRA money out too quickly - - resulting in what we call the "blowout"
- - may force a family to pay all of the taxes up front and lose over one-third of the IRA's future value - - literally throwing
away hundreds of thousands of dollars, or even millions!
Even if the IRA Owner Has Smart, Responsible Beneficiaries and Thinks the "Stretchout" Is Not a
Concern, Consider This…
the IRA beneficiary will properly do the RMD “stretchout” and pay the taxes gradually over his or her lifetime.
A lot can still go wrong.
When a beneficiary receives an
inheritance directly, as is the case when an individual is named directly as the beneficiary of an IRA, his or her inheritance
can then be exposed to a number of significant problems:
- The wrong
people may later inherit the IRA (the child, as initial beneficiary, could name his or her spouse as next beneficiary and
that spouse's next husband or wife or that spouse's children of another marriage could inherit the account!)
- The beneficiary, his or her spouse or children may have poor spending habits (be "spendthrifts"!).
- The beneficiary may lack good money management/investment skills.
- A beneficiary's spouse may take some or all of the IRA in a DIVORCE! (The income tax
laws, allowing an IRA transfer in a divorce to be tax-free, actually encourage the spouse to grab it and keep in mind the
statistical chance of a divorce is now over 50%!).
- If the beneficiary
is too young, elderly or disabled, he or she may not be able to properly manage his or her own affairs - - without unwanted
- A beneficiary who now or later in life receives
needs-based government benefits (like MediCaid nursing care benefits or supplemental disability income) may not qualify for
or lose those benefits.
- In most states (including California),
an IRA is not creditor protected and can be grabbed in a lawsuit, even a bogus one that forces a beneficiary to settle.
In other words, an inherited IRA not only needs to take advantage of
"stretchout" but needs protection too - - the kind that a trust can provide (which now leads us to the significance
of the IRS' approval of our IRA Inheritance Trust® stategy).
The IRS Previously Hasn't Liked Trusts as IRA Beneficiaries - - Until Now!
In its RMD regulations and previous rulings, the IRS has made it very
difficult for an IRA inherited through a trust to both qualify for maximum tax “stretchout” using each primary
beneficiary’s own life expectancy and also achieve the higher level of asset protection afforded by a trust that may
accumulate the RMDs and hold them for future distribution. Generally, one benefit had to be traded off for the other.
The new IRA Inheritance Trust® now permits the IRA owner and his
or her family to enjoy maximum “stretchout” and protection benefits at the same time. The protective features
of this trust have previously been tested and proven over many years of court decisions. And now, finally, the IRS has approved
the income tax “stretchout” feature as well (see PLR 200537044). This new standalone IRA beneficiary trust is
not the “garden variety” that has existed for some time, but rather represents a huge breakthrough. The IRA Inheritance
Trust® is the most advanced “next generation” trust that solves many earlier, tricky drafting problems associated
with maximizing both the stretchout and protection benefits.
Pension Protection Act of 2006 Makes the IRA Inheritance Trust® Even Better!
Effective January 1, 2007, the Pension Protection Act (PPA) significantly widened the
application of the IRA Inheritance Trust® to people who may never have considered this valuable planning tool before.
Previously, this Trust had no application to a company retirement plan
- - 401(k), 403(a), 403(b), 457, pension or profit-sharing plan, etc. - - unless and until the worker/participant reached
normal retirement age and took an “in service” distribution or retired, and then rolled over the company plan
into an IRA. The reason why is that company plans’ own rules usually forced a non-spouse beneficiary to take the entire
taxable distribution in 1 to 5 years, overriding the income tax “stretchout” rules available to IRAs.
Now, if someone has more than $150,000 in company plans, is still working
but has not reached normal retirement age, or has retired but left these moneys in the company plan, this plan participant
can take advantage of the stretchout and protection benefits for his or her family available through the IRA Inheritance Trust®.
The PPA permits non-spouse beneficiaries of company plans, or a Trust
established on the beneficiaries’ behalf, to do a rollover into an “inherited IRA” after the plan participant
passes away. In other words, a company plan participant can set up the IRA Inheritance Trust® now, make it the beneficiary
of the plan and let the IRA rollover occur later!
haven’t seriously considered the IRA Inheritance Trust® for a client because he or she is still working, or has
retired but still has money in the company plan, you definitely need to look into it right away!
Who Should Get an IRA Inheritance Trust®?
For anyone who has IRAs (including those owned by his or her spouse) and/or 401(k) or
other retirement plans that total over $200,000 - - this IRA Inheritance Trust® is virtually a "no brainer"
Simply stated, the income tax reduction and asset
protection planning that this trust now provides may save a million dollars or more for that IRA owner’s (or retirement
plan participant's) family!