Law News and Tips
Fred L. Vilbig ©2017
Whenever clients with trust-based estate plans sign their documents, we handle their real estate with a deed of some sort and their stuff (i.e., their tangible personal property) with an assignment.
With regard to their other assets, we typically don’t get actively involved. As Abraham Lincoln once said (and you should always quote Honest Abe to make a point), “A lawyer’s time is his stock in trade.” That is, all a lawyer has to sell is his or her time, so if they do work for someone, they are going to charge them.
To keep costs down, we give clients a detailed letter about funding their trusts. We tell them to go to their bank, their investment advisor, their broker, and their insurance agent. Clients just need to show them the letter and say “Do what he says.”
That almost always works… except with retirement accounts. Retirement accounts include IRAs, 401(k)s, and 403(b) accounts to name the most common ones. As you probably know, these are accounts in which you can deposit pre-tax money, let it grow tax deferred, and take it out after you reach 60. You only owe tax on what you take out, when you take it out. Of course, once you reach 70 ½ you have to take out your “required minimum distribution” (your “RMD”), but anything left in the account grows tax-deferred. It’s a good retirement plan many people take advantage of.
I’m going to focus on IRAs here because that is where most of the money ends up. If you are participating in a 401(k) plan, when you retire, they’ll probably make you roll it over into an IRA. You’ll have to be careful doing that too since there are time limits.
When someone has a trust-based estate plan, if they’re married, we always tell them to name his or her spouse as the initial IRA beneficiary. That allows for the maximum planning opportunities on the death of the first spouse to die. The surviving spouse can do a tax-free rollover, and there may be some tax benefits available. You want to leave your options open.
But on the death of an IRA owner where there isn’t a surviving spouse, I tell clients to name the trust as the beneficiary. In 2015, the US Supreme Court ruled that an inherited IRA is liable for bankruptcy claims. I haven’t seen the cases, but I’d have to think that regular lawsuits won’t be far behind. Running an IRA through a trust can give a beneficiary some asset protection.
Here’s where we get the questions. Some financial planners worry that if you name a trust is the beneficiary of an IRA, on the death of the employee/owner, all of the assets in the IRA will become immediately taxable. That is not true.
In 1999 the IRS promulgated some regulations to cover this very point. They said that if your trust contained their magic language, it would not cause the immediate taxation of 100% of the IRA. But what the IRS said was that the trust could not hold on to the IRA distributions. If the trustee received the RMD, it had to pass it through the trust and pay it to the named beneficiary. If there are multiple beneficiaries, then the IRA administrator can break the IRA into equal subaccounts for each beneficiary, but each payment still had to pass through the trust to the appropriate beneficiary.
That has been the law since 1999. I can point to the section in the trust agreement with the magic language, but we still get pushback. Maybe it just seems like it’s too good to be real, but here it’s real.
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