If you own an “Individual Retirement Account” (“IRA”) then congratulations, you are fortunate: IRA’s are legitimate tax shelters allowing persons who have earned income to deduct their IRA contributions from their taxable income and to defer taxes on contributions and IRA earnings until the IRA distributes payments to you and/or your death beneficiary. Distributions are then taxed as ordinary income (like wages). Here are some important planning considerations to help you select your IRA death beneficiaries and obtain the best possible income tax deferral for you beneficiaries.
You, as the IRA “participant” (owner), must commence IRA “Required Minimum Distributions” (“RMD’s”) no later than the year after you turn age 70 1/2, the “Required Beginning Date” (“RBD”). At that time the RMD amounts are determined based on your life expectancy using IRS tables.

The good news, however, is that by naming “Designated Beneficiaries” (“DB” ) – only an individual, a group of individuals, or a so-called “see through” trust qualify as a DB — to inherit your IRA you can “stretch out” (increase) how long the money remains inside of the IRA and so grows income tax free (after you die) for the sake of your loved one. Remember, only DB’s are eligible for the special “stretch out” treatment. Beneficiaries that are charities, estates and those trusts that do not qualify as “see through” trusts, however, are not DBs, and don’t qualify for stretch-out RMD payments.

Designating your spouse as your sole DB allows the greatest deferral and most flexibility. Only a spouse may “roll over” your IRA and therey become the new IRA participant, and so redefine her own RBD (based on when she reaches age 70 ½) and also name her own DB’s.

Other “non spousal” DB’s (e.g., your children) must commence receiving RMD’s the year after you die. The amount of their RMD’s is usually based on their own life expectancies, provided that the IRA is divided into separate inherited IRA accounts for each beneficiary.

If a “see-through” Trust is the DB, then the amount of the RMD is based on the life expectancy of the oldest possible trust beneficiary. Unfortunately, the younger trust beneficiaries cannot have their own RMD computed based on their longer life expectancies, even though the trust is divisible into separate shares. So, this means that if it is possible for your 90 year old aunt to inherit under the trust (should your children die while the trust is in existence), then the RMD’s for the IRA payments to the “see through” trust are computed based on your aunt’s life expectancy, even though there is only a very, very remote chance that she would inherit instead of your children! Be extremely careful before making a trust a beneficiary.

Lastly, if you choose a trust as a beneficiary, then you normally want a “see through” trust. The IRS’s “see through” trust rules are very complicated and require much expertise. It is usually advisable to name individual DB’s. But, sometimes it is necessary to name a trust such as in second-marriages (to benefit your spouse and children) or when the beneficiary is a minor, a person with disabilities, someone receiving welfare benefits, a person unable to manage money, or a person with creditor problems.

Editor’s Note: Dennis A. Fordham is an attorney licensed to practice law in California and New York. He concentrates his practice in the areas of estate planning and aspects of elder law. His office is at 55 1st Street, Lakeport, California. He can be reached by e-mail at dennis@dennisfordhamlaw.com or by phone at 707-263-3235.

 

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