“When a Trust is a Must”
Part 3 in a series by Joanne Seminara, Esq.

An IRA Trust is an important estate planning tool for maximizing, protecting and managing your Individual Retirement Account or IRA.  Using this tool, an IRA Trust, rather than one or more individual beneficiaries are named as the IRA beneficiary.  The IRA Trust, in turn, designates the beneficiaries of the asset. Properly drafted, an IRA Trust allows extended tax deferral benefits by “stretching out” the payments over the beneficiary’s life expectancy.

An IRA Trust may be advisable for one of more of the following reasons:

  • Beneficiary is too young to manage her own affairs
  • Beneficiary is disabled
  • Asset protection and creditor protection
  • The need to preserve assets for children in second marriages and/or non-traditional family members
  • Wealth preservation
  • Tax planning

Consider the following situation.  Anna, age 78, is a retired widow who, after working as a paralegal at a large law firm for 40 years, has amassed a $500,000 IRA.  Anna has one child,  Nancy, age 50, from whom she is estranged, and 2 granddaughters, who are 13 and 15.  Nancy is married to Mike, a spend-thrift who does not contribute much support to the household.  Anna does not wish to leave her substantial IRA to her daughter and wants to leave her sizable IRA to her grand-daughters so they have the chance of a good start in life.  How can Anna safeguard her hard earned IRA assets for their future needs?

The solution is an “IRA Trust” for the benefit of her granddaughters, who may not be adults or mature enough to manage their own assets at Anna’s death.  A “Trust” allows a person, called a Trustee, to manage assets for the benefit of another person to ensure the assets are used as intended. An IRA Trust is specifically drafted to hold IRA assets, which are typically “tax deferred,” that is, assets for which income taxes have not been paid and for which taxes will be due when the asset is distributed, or “paid out,” in the future.

A designated beneficiary of a retirement benefit plan is generally required to take minimum required distributions (or “MRDs”) starting at age 70.5 over his or her life expectancy.  If a Trust is the beneficiary of an IRA and all the Trust beneficiaries are individuals, the oldest beneficiary‘s life expectancy will be used to calculate the MRDs.  An IRA Trust is the perfect tool for Anna because it allows for tax deferral on the IRA assets (to the extent they are not paid to Anna and taxed during her lifetime) to be further “stretched out” past her lifetime and continued over the lifetime of her now 15 year old granddaughter for the benefit of both granddaughters.

An IRA Trust can be drafted as an “accumulation trust” so that distributions to beneficiaries are accumulated and distributed at certain defined beneficiary ages, or a “conduit trust” which requires direct mandatory distributions to a beneficiary annually over his or her life expectancy term. IRA Trusts can even allow for the flexibility to change the distribution plan during the term of the Trust if the Trust provides for a “trust protector” to make this decision.

Creators of IRA Trusts, called the Grantors, like Anna, should carefully consider the age of their beneficiaries and their likely needs when deciding between an Accumulation Trust and a Conduit Trust.  This decision should follow review of the time period that the IRA assets will remain undistributed or “in trust,” when and how the distributions will be made, and the tax ramifications for such assets.

Trusts are taxed at higher income tax rates than individuals.  Therefore, to the extent the income earned by the IRA is “accumulated” within the Trust and not paid out to an individual beneficiary in any year, the Trust will have to pay income taxes at this higher rate.   Alternatively, an IRA “conduit” trust which provides for regular mandatory distributions to a younger beneficiary may achieve more favorable income tax treatment. This type of Trust, which regularly sheds income over the lifetime of the beneficiary, allows income tax to be paid at the individual’s tax rate, which is typically lower.

There are other issues to consider when deciding between an Accumulation Trust and a Conduit Trust.  If the Grantor wishes to name more than one beneficiary and/or a contingent beneficiary, and one beneficiary is significantly older, a Conduit Trust may be more suitable. Conduit Trusts offer the advantage of using the often longer life expectancy of a single beneficiary, and thus greater tax deferral and growth, rather than the shorter life expectancy of the older beneficiary.

IRA Trusts are advanced estate planning tools governed by complex Federal Internal Revenue Code regulations.  There are special restrictions and terms that must be included in an IRA Trust for it to be effective. An IRA trust should be considered in consultation with experienced estate planning attorneys and financial advisors.

Additional resources provided by the author

Part 1: When a Trust is a Must

Part 2: When a Trust is a Must:  “Long-Term Care and Asset Protection”

 

Joanne Seminara

GRIMALDI & YEUNG LLP:
Phone: 718-238-6960
Brooklyn and Manhattan Offices:

9201 4th Ave, 6th Floor
Brooklyn, NY 11209

546 Fifth Avenue, 6th Floor
New York, NY 10036

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