Many folks have large retirement accounts. According to the Investment Company Institute 2016 Yearbook, in 2015, members of 60 percent of U.S. households had invested $24 trillion in retirement market assets, including individual retirement accounts, 401(k)s, 403(b)s, simple IRAs and others. This article discusses IRAs, and someone with any others should consult legal and financial advisers. In fact, every general rule stated in this article is subject to exceptions, and there may also be specific situations where these rules should be purposefully ignored. This article should be considered as simply a guide for asking questions of your adviser, rather than a road map for do-it-yourself action.
The typical estate plan for a married couple with IRAs is to name the surviving spouse as the first (or primary) successor owner. There are special tax benefits for a surviving spouse that do not apply to any other possible successor owners. There are other options, but they should not be pursued without specialized advice.
Classically, a married couple names their children as the contingent or remainder successor owners who will receive the accounts upon their parents’ deaths. Single IRA owners may name their children as primary successor owners, and those without children typically name other family members to receive these accounts. Again, there are other options (including some charitable ones) that should be considered after appropriate advice.
Most IRA owners want to keep IRA assets invested as long as possible. Because growth is not taxed until the funds are withdrawn, they will grow faster — the longer they are invested, the greater they will be. This is called “stretching” the IRA.
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One of the benefits to naming a surviving spouse as the first successor owner is that the spouse is permitted to “roll” the IRA into his or her own name as one of the available options. No one else has this option, and everyone else must begin withdrawing funds (and paying taxes) as soon as the IRA becomes theirs, called the minimum required distribution. For younger successors, the MRD is not great, an 8-year-old successor owner will need to withdraw a little more than 1 percent as his or her MRD. In contrast, a 65-year-old successor would have an MRD of almost 5 percent, and the MRD for a 71-year-old spouse would be just more than 6 percent.
Thus, it makes sense to name as young a beneficiary as possible so as to lengthen the process to maximize the effect of compounded tax-deferred growth. For example, if a 70-year-old widow leaves an IRA with $100,000 to an 8-year-old great-grandchild (assuming there are no generation-skipping tax considerations), and the IRA grows at 3 percent, then at age 65, the great-grandchild will have withdrawn more than $207,000 from the account and it will still be worth more than $130,000 — quite a positive result for a $100,000 IRA. (At a higher rate of growth, like 6 percent, that same $100,000 IRA would be worth $700,000 at age 65, and MRD withdrawals would be as high as $40,000 per year.)
Most IRAs don’t last this long, and it would not surprise anyone that when our 8-year-old turns 18, he or she will find a reason to withdraw much of this inherited wealth. One way to be certain that MRD withdrawals are made and to limit extra withdrawals to actual needs is to name a trust successor owner. IRS regulations do not allow many traditional trusts to stretch. However, if the trustee is required to withdraw and pay out at least the MRD each year, the IRS will allow the trustee to use the great-grandchild’s life expectancy. This is called a “conduit” trust. Another IRA trust is called an “accumulation” trust, but these are fairly complicated to set up. Describing any IRA trust as “simple” might be stating an oxymoron, but compared to an accumulation trust, a conduit trust is straightforward for knowledgeable counsel.
The trustee of a conduit trust may make larger withdrawals if necessary (like helping with medical expenses or college), but the beneficiary will need to convince the trustee that other withdrawals are truly necessary. The trustee might say, “I agree you need a new car, but look for a good used Chevrolet rather than the new Tesla you want.” Several institutions offer “Trusteed IRA” plans for a fee, and this has the added benefit of having professionals invest the IRA funds, which may result closer to 6 percent than 3 percent growth, as in the example above; it also provides continuity in trust management. Other investors opt for family members as trustees, which may save money in fees but might impose a burden on family members.
With good planning, it is possible to provide a great gift to descendants; a trust makes it more likely they will receive it.
Amos Goodall is a certified elder law attorney practicing in State College with Steinbacher, Stahl, Goodall & Yurchak. He is also a fellow of the American College of Trust and Estate Counsel.