Russo Law Group, P.C. is pleased to share this article on behalf of guest author Michael Gilfix. 

The IRA Trust is the preferred method to give the beneficiaries of your retirement account protections that are otherwise not available to them.

Why use the IRA trust? Rather than simply naming beneficiaries for your IRA accounts, we strongly recommend that we instead prepare one or more IRA trusts to protect your beneficiaries, who are perhaps your children and grandchildren.  There are four good reasons why this makes sense.

1. Choose Future Beneficiaries: The IRA trust lets you identify beneficiaries of your accounts even after your first beneficiaries pass away. If you instead leave your retirement accounts directly to identified beneficiaries, they will each determine who inherits their respective inherited IRA assets remaining at the time of their deaths.

A married beneficiary might name his/her spouse to inherit the remaining assets, potentially causing the retirement account to go outside the family. A beneficiary who passes away but was unable to choose the next IRA beneficiary, perhaps because of incapacity or insufficient time, will pass the inherited IRA to the beneficiary’s estate, losing all income tax protections and likely a costly probate administration.

When creating an IRA Trust, you choose the order of future beneficiaries and avoid these complications. We believe that you can and should control where your retirement accounts ultimately go.

2. Protection from Creditors: Anyone can be sued. An automobile accident with claims beyond insurance coverage, a slip and fall on your property, or a business deal gone bad can all be catastrophic. Unfortunately, inherited IRA accounts are not protected from a beneficiary’s creditors in California or in bankruptcy. If retirement accounts are instead directed to an IRA trust, the trustee has the power to protect IRA assets from creditors.

3. “Stretching” Income Tax Benefits: Upon your passing, a retirement account beneficiary can either receive distributions over her lifetime or remove all retirement account assets immediately. The problem with the latter approach is that all income tax then becomes due, potentially with a high tax rate. With the IRA Trust, the trustee ensures that the inherited IRA would continue to be managed and stretched over the beneficiary’s lifetime. In addition to avoiding extraordinary, accelerated, and avoidable income tax exposure, this approach maximizes the likelihood that assets will be available for future generations when the beneficiary passes away.

4. Protects the IRA from Poor Judgement or Inappropriate Distributions: Putting a trustee in charge of an inherited IRA effectively protects the IRA from inappropriate distributions or a beneficiary’s poor judgement. Too many beneficiaries have questionable judgement, capacity issues, or even drug or alcohol abuse problems. The IRA trust protects such beneficiaries from their own poor judgement and preserves assets for their own future.

Frequently Asked Questions:

1. How Does the IRA Trust fit into your Estate Plan and Living Trust? The IRA trust is independent from and complementary to your living trust. The IRA trust is created now and does not receive assets until you and your spouse are deceased. Typically, the trust is named a beneficiary of all retirement accounts.  Depending on the trust provisions, the trustee might give all retirement account distributions directly to the beneficiary or might use them liberally for the beneficiary’s benefit.

Upon the beneficiary’s passing, assets remaining in trust or in the inherited IRA will continue for the benefit of the next trust beneficiary.

2. What Happens After I Pass Away? If you created one or more IRA trusts, your trustee will provide a copy of each trust to the financial institution managing your retirement accounts and create an inherited IRA for each beneficiary under an IRA trust. The trustee will manage the inherited IRA for each beneficiary and receive the required minimum distributions. Depending on the terms of the IRA trust that you and your attorney choose, the distribution might be paid directly to the beneficiary, or some cases, used by the trustee for the beneficiary’s benefit.

If you did not create an IRA trust, each designated beneficiary will claim her share of your retirement accounts and decide whether to take an outright distribution or stretch the income tax savings with lifetime distributions. If taking lifetime distributions, the beneficiary will have the opportunity to choose the next, or successor, beneficiary to receive the account in the event of her death. Under California and IRS law, the beneficiary will be the owner of her own inherited IRA and exposed to creditors.

If you did not designate beneficiaries of your retirement accounts, regardless of whether you created an IRA trust, the retirement accounts will pass to your probate estate. Most of the income tax savings will be lost and the accounts will likely have to go through an expensive and intrusive probate administration.

The Bottom Line:  The IRA trust makes sense for most people, particularly those with retirement accounts worth more than $250,000.

Michael Gilfix
Gilfix & La Poll Associates, LLP
2300 Geng Road, Suite 200
Palo Alto, CA 94303
650-493-8070