Planning for Retirement Assets Can be Difficult

In IR-2013-35 (March 28, 2013), the IRS reminded us that in most cases seniors who turned age 70½ during 2012 need to start taking Required Minimum Distributions (RMDs) from their IRAs, 401(k)s, and other retirement plans by April 1, 2013. The April date only applies to persons who are taking their first RMD. For all subsequent RMDs, the senior will need to take the distribution by December 31st of that year. Of course, seniors who do decide to delay their first distribution to the year following the year they turn age 70½, two distributions will need to be taken – the one by April 1st (for the previous year) and a second one by December 31st (for the current year). Generally speaking, seniors taking RMDs will use Table III, otherwise known as the “Uniform Table,” to determine the amount of their RMD each year.

Inherited IRAs are Different

The rules are different if the IRA in question is an “Inherited IRA.” The beneficiary is required to start taking distributions from the Inherited IRA no later than December 31st of the year after the year of the IRA owner’s death. The RMDs for the beneficiary are determined using Table I, the “Single Life Expectancy Table.” Unlike the Uniform Table, the beneficiary only needs to refer to the table once (not annually as with the Uniform Table) and he or she merely reduces the factor first obtained by one each year. For instance, a beneficiary age 55 would have an original factor of 29.6. The next year, when the beneficiary is 56, the factor would be 28.6 (29.6 – 1 = 28.6). The following year it would be 27.6, and so on. The value of the Inherited IRA is divided by the factor to determine the RMD amount. For instance, if the value of the inherited IRA is $100,000, the RMD for a 55-year-old would be $3,378 ($100,000 / 29.6). In 30 years, the beneficiary would have withdrawn the total amount of the Inherited IRA.

Inherited IRAs Paid to Trusts

It is sometimes desirable to name a trust as the beneficiary of an Inherited IRA. This might be because the intended beneficiary is a special needs child, a minor, or a person who is incapable of managing his or her financial affairs due to gambling, alcohol, or drug addiction. Under most circumstances, the IRS considers a trust, estate, or entity (such as a charity) to have no life expectancy. As a result, with such beneficiaries, the IRS would usually require the entire amount of the inherited IRA to be withdrawn by no later than five years after the date of death of the IRA owner. This negates the ability to continue to defer income taxation and allow the full value of the IRA to continue to grow tax-deferred, as demonstrated above with our 55-year-old beneficiary. Since he or she is only required to take an RMD of $3,378 in year 1, the remaining earnings, if any, and principal can continue to grow, tax-deferred, for another 28 years.

However, if the trust is a “qualified designated beneficiary trust,” the trust is disregarded and the life expectancy of the oldest beneficiary of the trust is used. The IRS has issued some very technical regulations detailing what is required for a trust to be classified as a qualified designated beneficiary trust.

This begs the question of who is the oldest beneficiary of the trust. Take the situation where a trust designates a child of the trustor, who is 45 years old, as the primary beneficiary. If the child was not then living, his share is to be distributed to equal shares for his then-living children. If he has no children living at the time of the death of the trustor, the contingent beneficiary is the child’s uncle, who is 70 years old. Under the IRS rules, is the oldest beneficiary of the trust the child who is 45 years old, or the uncle, who is 75 years old? As with all legal issues, the answer is – it depends. Pursuant to the IRS regulations, we would first have to ascertain whether the child is alive at the death of the IRA owner. If the child is deceased, we would next inquire whether any of his children are then living. If the child or his children are alive and the trust is properly drafted, the uncle will be disregarded in determining who the oldest beneficiary is. If the trust is not properly drafted, the uncle would be considered the oldest beneficiary. Of course, if the child and grandchildren had all predeceased, then the uncle would be the actual beneficiary and his life expectancy would again be used. This requires pretty complicated calculations and drafting. Because of this complexity, many financial planners, insurance companies, and banks take the position that a trust should never be named as the beneficiary of an IRA or other retirement asset. However, such simplistic planning cannot always be achieved when the beneficiary circumstances dictate that he or she cannot be named the direct beneficiary of the retirement funds. For this reason, you should seek the advice of an experienced estate planning attorney who is familiar with the interaction of trusts and retirement assets if you have sizeable retirement assets and you want to leave them in trust for your beneficiaries.

Our law firm focuses on estate planning, including estate planning for persons with large retirement assets. As a member of the American Academy of Estate Planning Attorneys, our firm is kept up to date with information regarding the ever-evolving regulations dealing with retirement assets and new income and estate tax developments. You can get more information about a complimentary review of your clients’ existing estate plans by calling our firm.