If you have named your children as beneficiaries of your individual retirement account (IRA), you have likely made a mistake that exposes the IRA to your children’s spouses, to their creditors and to easily avoidable future inheritance and estate taxes. Forming and naming an IRA Trust for your child as the beneficiary easily corrects this mistake.
Congress requires that all qualified retirement plans—including IRAs, SEP-IRAs, 401(k) plans, and 403(b) plans—must allow an IRA Trust to be named as a beneficiary. By doing so, Congress allows you to form an IRA Trust for your child that allows the Inherited plan to remain tax-deferred.
Because your child does not own the Inherited IRA, it is sheltered from your child’s creditors as well as your child’s divorce complications. Further, the IRA Trust excludes the IRA from your child’s estate for death tax purposes. As a bonus, you may dictate that any amount remaining at your child’s death passes to your grandchildren, thereby avoiding your daughter-in-law or son-in-law.
The IRA Trust provides huge benefits for your children with little ongoing costs if the child serves as the trustee.
If your IRA passes into a properly drafted IRA Trust for your child at your death, here are some of the many advantages:
- Divorce Protection: The trust owns the IRA, not your child. If your child divorces, the IRA is not included as marital property to be divided as part of the divorce proceedings.
- Creditor Protection: According to the Supreme Court, if your child owns the Inherited IRA, it is not protected from the creditors. If you use an IRA Trust the trust is the owner, not your child. This means your child’s creditors have no claim against the IRA.
- Estate and Inheritance Tax Protection: If you leave your IRA to your child, then it is included as part of your child’s assets for inheritance and estate tax purposes. By using the IRA Trust, the trust is the owner, not your child. At your child’s death, the Inherited IRA is not included in the child’s taxable estate.
- Low Cost: If you name your child as the trustee, your child will not charge a fee, so there is no trustee cost.
- “Stretching” the IRA: If drafted correctly, the trustee is able to stretch the IRA over the beneficiary’s lifetime, securing all the same tax deferral benefits that the beneficiary would have had if the beneficiary held the Inherited IRA in his or her own name.
- Keeping the Money in the Family: If you give your IRA to your child then your child selects who receives the remainder at your child’s death. This will likely be your child’s spouse. By using an IRA Trust you select the successor beneficiaries. You can keep the money in your family by naming your grandchildren as the successor beneficiaries.
In short, IRA Trusts provide huge benefits at low cost. The reason you have not heard about them is likely because the rules surrounding IRAs are very complex, which cause many professionals to avoid the issue. This avoidance could cost your family dearly. For more detailed information, feel free to contact me.