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Estate Planning: True or false … or somewhere in between?

David C. Pettig

Estate Planning for Retirement Accounts

Questions:

1. Designating a trust created for a surviving spouse as the sole beneficiary of an IRA is no different than designating the spouse as the direct beneficiary because the minimum required distribution (MRD) in both is based upon the spouse’s life expectancy. (Assume the trust has conduit provisions.) __True __False __It Depends

2. A charity is virtually always the best recipient of IRA funds because it does not have to pay income or estate taxes on the distribution, whereas individuals may be hit with both. __True __False __It Depends

3. An IRA that has been making distributions to a trust must be terminated when the trust ends. __True __False __It Depends

4. IRA benefits should be made payable to a credit shelter trust to the extent there are insufficient non-retirement assets to fully utilize the federal estate tax exemption. __True __False __It Depends

5. If there is no surviving spouse, designating conduit trusts for children as beneficiaries of an IRA is a “no-brainer” because of the benefits of stretching the distributions over their life expectancies. __True __False __It Depends

Answers:

1. False. It is true that the MRD is based upon the surviving spouse’s life expectancy. However, the trust cannot recalculate the MRD as the spouse ages. If the spouse has a 20-year life expectancy then the spouse (via the trust) must take out 1/20 of the account in the first year, 1/19 in the next year, etc. The result is that the IRA may be exhausted before the spouse dies.

On the other hand, if the spouse is the direct beneficiary, the MRD is recalculated each year so that the IRA will not be exhausted prior to the spouse’s death.

2. It Depends. Charity can be a good choice for small bequests. You have to make an analysis of the tax ramifications and the period of time over which the IRA will be distributed to determine if distribution to the charity is better than a stretch IRA. The answer is different for a 60-year-old beneficiary versus a 16-year-old. The analysis should take into account the value of client’s taxable and tax deferred assets, the life expectancy of the individual beneficiary, the expected appreciation over individual beneficiary’s life expectancy (and, perhaps, consultation with a Ouija board). One should also consider the impact of a lifetime, rather than testamentary charitable gift of non-qualified assets.

3. False. The Trustee may distribute the IRA “in kind” to the trust remainder beneficiaries. The applicable distribution period that existed prior to the distribution of the remainder continues. For example, if six years remained in the applicable distribution period for trust beneficiary, then the remainder beneficiaries must take distributions over a period of no more than six years. They also must meet the minimum required distribution obligation.

4. It Depends. You have to consider the relevant factors and push a pencil. The factors include a comparison of the estate tax savings to the potential benefits of deferral, the probability of the survivor’s estate being subject to estate taxes, the possibility that income tax rates will increase (or decrease) over time, and whether or not the family will actually take advantage of the deferral.

5. It Depends. In one sense this is true because the MRDs will be paid out over the child’s life expectancy and if the child receives the IRA directly. An individual other than a spouse cannot roll over the IRA and recalculate the MRDs as a spouse can. On the other hand, there may be unforeseen (or foreseen) circumstances in which naming a trust as beneficiary is the wrong thing to do. One circumstance that comes to mind is a child/beneficiary who qualifies for public benefits who might lose some or all of those benefits because of the mandated distributions of a conduit trust.

Bottom Line:

Obfuscation has been thriving in halls of Congress for decades. Simplification is not even on the radar. The best we can do is try to keep up with the most of the changes and to take advantage of excellent secondary materials. In the realm of retirement account planning, I have never seen anything more comprehensive and understandable than Natalie Choate’s Life and Death Planning for Retirement Benefits. The seventh edition was published in 2011.

David C. Pettig, principal with Pettig Torres PC, has been practicing trust and estate law for more than 30 years. He can be contacted at dcpettig@pettig.com or (585) 586-1430.