Posts Tagged ‘Irrevocable trusts’

According to conventional wisdom you should always name your spouse as beneficiary of an IRA. Let’s smash some traditional pumpkins (I am writing this in October, after all). Read on to understand why it might be a great idea to name a trust as the beneficiary of an IRA and what some of the trade-offs of doing so are.

Standing on Tradition: Naming The Spouse As IRA Beneficiary

There really is a good reason for naming the spouse as IRA beneficiary . . . much of the time. As I have written, the beauty of an IRA is that the longer money can be allowed to languish in an IRA, the more it will grow without being burdened by taxes. Because of that, the usual thinking is to try and take out as little as possible. On the other hand, there are all sorts of tax rules about when someone MUST take distributions and how much those distributions must be. Remember the rule:

SOMEDAY, SOMEHOW, SOMEONE WILL PAY TAXES ON THE IRA.

Why Naming A Spouse The IRA Beneficiary Is So Slick (Usually)

If a spouse “inherits” an IRA, she can treat it as her own. This means she does not have to begin distributions until she is 70 ½. When she does begin taking distributions she can use a special table that assumes she has a husband 10 years younger (heh, heh, heh) even though she may have just become a widow. That means MUCH smaller mandatory distributions because they are being spread out over her life and the life of Mister-Make-Believe-Ten-Years-Younger-Romeo.

The special spousal rules for inherited IRAs also say that she can name the kids as beneficiaries and upon her death they will have separate IRAs they can take out over their life expectancies (although I have found – quite nonscientifically – that most IRAs inherited by adult children quickly become new cars or tuition payments!).

On The Other Hand . . .

Sometimes naming a spouse as IRA beneficiary is a bad idea. There may be reasons that outweigh the usual good tax reasons for naming a spouse. For example, I often encounter couples concerned about protecting assets for a surviving spouse in case he or she ever needs to go into a nursing home. An IRA left directly to a spouse will be a countable asset for Medicaid purposes. There may be other good asset protection motives involved, as well.

The solution may be to name a trust as the beneficiary of the IRA. That way, IRA assets may be protected while remaining available to benefit the surviving spouse.

There are a number of ways a trust can be designed, depending upon what the client and I are trying to accomplish. Much of how a trust will be treated depends upon whether it is something the IRS calls a “designated beneficiary.”

Is A Trust A Designated Beneficiary?

If a trust benefits only real live (as in “beating hearts living”) people then the trust will be a “designated beneficiary.” If a trust says “Mom is the primary beneficiary, then the kids” that will suffice. If the trust says “Mom may receive some, but not necessarily all benefits, then when Mom dies the North Carolina Zoo takes” the trust will not be a designated beneficiary.

If a trust is NOT a “designated beneficiary” of an IRA, then the IRA must be distributed within five years if the owner dies before 70 ½. If an IRA is not huge, being forced to completely distribute it within five years is not necessarily bad.

If the owner dies after age 70 ½, however, then the trust can take distributions over what would have been the deceased owner’s life expectancy had he been alive each year. That actually will be a bit faster than if he had been alive and married because the rules use different tables that calculate distributions as if the deceased owner were still alive and single. On the other hand, for older spouses about the same age, there may not be too much difference. The difference is if Mom had inherited directly she would have used a table that pretended there was the “Ten Year Younger Romeo” (slower distributions to account for the younger Romeo’s added life expectancy) but the trust is stuck with using a single person’s table (faster).

Bottom line: If a trust fails the “designated beneficiary” rule it means the IRA must be distributed over five years if the owner died before age 70 ½ and over the owner’s life expectancy (pretending he is alive and single) if he dies after age 70 ½.

Should Everything Be Distributed To Mom?

If we set up a trust to qualify as a “designated beneficiary” the next issue is to decide whether to make the trustee pay out to Mom all of the distributions the IRS says the trust MUST take from the IRA (this is called a “conduit trust”), or to let those IRA distributions accumulate inside the trust (where they are protected).

If the trust is a conduit trust, Mom gets all IRA distributions and she pays all income taxes (probably at her low tax rate). Also, if a trust is a conduit trust the IRA distributions can be stretched out a little bit more than if the trust was an accumulation trust. It also means that if Mom goes to the nursing home on Medicaid, all of those IRA distributions will be paid to the nursing home before Medicaid kicks in.

If the trust gives the trustee the right to accumulate IRA distributions and to decide whether to pay some, all, or none of the IRA distributions through to Mom, the IRA will be distributed to the trust slightly faster, but the assets will be safe from nursing home expenses. To the extent the trustee decides not to distribute to Mom (maybe she is in a nursing home on Medicaid) the IRA distributions being held in the trust will be subject to income taxation at much higher rates than Mom would have paid had the trustee passed the IRA distributions on to Mom. On the other had, if they were paid out to Mom, everything would be gone!

Get Help!

This is a complex topic. The purpose of this brief article was to give an overview of the possible advantages of naming a trust as IRA beneficiary. Sometimes it is a great idea, and other times it may be a really bad idea. Bring it up with your attorney or financial advisor and see what she says.

Coastal Senior is a Georgia monthly periodical covering the South Carolina and Georgia low country.  Bob Mason is its legal columnist.

Vacation property and “second homes” – whether in the mountains or at the beach – present a number of legal and tax planning opportunities.

First, consider probate avoidance, particularly if the property is located in a state other than the owner’s primary residence. buy sildenafil The problem arises when the owner dies with title to the property in her name.

In addition to a probate proceeding in the owner’s state of residence, there will need to be an “ancillary probate” proceeding in the state of the second residence. A Big Hassle.

A fairly simple revocable trust, or living trust, could completely avoid the probate process in the second state. Before the “owners” death the trust owns the property. After the “owners” death, the trust continues as the record owner. Thus, no probate.

Even Fancier

Certain types of trusts can be created that protect the property for the family after the incapacity of the principal owner. If the trust is irrevocable and correctly designed, the property will not count for Medicaid purposes. Start early, however, because it’ll take five years to completely protect the home for Medicaid.

While in the trust, the property will also be immune from the liabilities of the children the owner may have originally been thinking of transferring the property to.

Tax Smart

Further, if the property is transferred directly to the children, the parent’s “tax basis” also transfers to the children. Tax basis is simply the floor value used for calculating the “profit” that someone will realize if they sell the property.

In the hands of the person who bought the property, tax basis will be what he paid for the property. In the hands of a person who inherited the property, basis will be whatever the property was worth when the person inherited the property. Importantly, in the hands of a person who received the property as a gift, basis will be the same as the basis of the person who made the gift.

What difference does this make? Say Jack’s basis in Palm Isle is $25,000 because that is what he paid for it or because that is what dad’s basis was when he gave it to Jack. Later Jack sells the property for $100,000. His “gain” or profit is $75,000. Uncle Sam and most states are keenly interested in gain, because they tax it!

On the other hand, if Jack put the property in a properly designed trust that provided his children would receive the property on Jack’s death, and on Jack’s death the property is worth $100,000, that will be the basis in the hands of the children. If they sell the property for $100,000 there will be no (as in zero) taxable gain. Not too shabby.

Wait, there’s more. If the property is Jack’s principal residence and the trust has been properly designed, the trust will qualify for the capital gains tax exclusion that would apply if Jack directly sold his residence. To use a South Carolina term, that is “elegantly shabby”.