The Wealth Counselor provides helpful information regarding how to use IRAs and retirement plans
to transfer wealth, addresses common misconceptions on this topic, and
explains the importance of naming a trust as beneficiary. In this blog
article, we will begin by covering the basics.
If after reading this explanation, you have any questions or concerns for
your clients’ estate planning and retirement planning needs, please
call my office to speak with me or my plan administrator, Kim Kaskel.
Surviving Spouse as Sole Beneficiary
If the surviving spouse is the only beneficiary, he or she can roll over
the inherited benefits into his or her own retirement plan or elect to
treat an inherited IRA as his or her own IRA. There is no deadline by
which the spouse must make the rollover decision, but until the rollover
is made, minimum required distributions would have to be under the inherited
IRA rules based on the spouse’s age unless the plan requires more
A spouse who is under 70 1/2 can postpone distributions until he or she
attains the age of 70 1/2. In addition, after rollover the spouse can
name his or her own beneficiaries who can then use their own life expectancies
after the surviving spouse dies, resulting in the maximum stretch-out.
If the surviving spouse is under 59 1/2, special care must be taken in
deciding whether and when to do a rollover. This is because distributions
taken from the account after rollover and before the survivor reaches
age 59 1/2 are subject to the 10% early withdrawal penalty.
For Illinois residents, if the spouse beneficiary does a rollover to his
or her own IRA the assets will be protected from his creditors and predators
under Illinois law. Note, however, once the surviving spouse has died,
recent case law indicates that the beneficiaries of the inherited IRAs
do not have the same asset protection. Thus, after an accident or lawsuit,
a judgment creditor could take away an inherited IRA account. Naming a
special retirement trust as contingent beneficiary can solve this problem.
Trust as Beneficiary
There are two common myths about estate planning for qualified retirement
plans and IRAs:
(1) You cannot name a trust as beneficiary and get a stretch-out; and
(2) Naming an individual as beneficiary will result in a stretch-out.
The problem with naming an individual as beneficiary is that he or she
is likely to cash out the IRA or plan account, thus negating the participant’s
careful planning for long-term tax-deferred growth. Example: A 25-year-old
inherits a $100,000 IRA. Will he choose a $60,000 automobile (the amount
after cashing in the IRA and paying the income tax) or $400,000 in after-tax
income over his or her life expectancy (based on 5% growth and combined
state and federal income tax of 35%)? If the client’s goal is to
preserve tax-deferred growth, it is advisable to have a trustee involved
who will ensure that happens.
Normally a trust is a non-individual and cannot qualify for Designated
Beneficiary status, but it is possible to name a trust as beneficiary
and still have a Designated Beneficiary for purposes of determining minimum
required distributions. Special rules allow a “see-through trust”
that lets you look through the trust and treat the trust beneficiaries
as the participant’s beneficiaries, just as if they had been named
directly as beneficiaries by the participant.
Requirements for a See-Through Trust To qualify as a see-through trust, the trust must meet certain criteria:
(1) The trust must be valid under state law.
(2) The trust must be irrevocable or will, by its terms, become irrevocable
upon the death of the participant.
(3) Certain documentation must be provided to the plan administrator by
October 31 of the year after the year of the participant’s death.
(4) Trust beneficiaries who are to be included in the Designated Beneficiary
determination must be identifiable from the trust instrument and all must
A Designated Beneficiary need not be specified by name as long as the individual
who is to be the Designated Beneficiary is identifiable under the plan.
Thus, the members of a class of beneficiaries capable of expansion or
contraction will be treated as being identifiable if it is possible to
identify the class member with the shortest life expectancy. For example,
“my descendants” is a class that can be identifiable even
if they are not individually named.
Stand-Alone Retirement Trust
Using a stand-alone trust to receive retirement plan benefits is often
the best solution. As you have seen, qualified retirement plans and IRAs
are special assets with unique tax rules that provide well for accumulating
wealth for retirement but do not work so well when trying to pass this
wealth on to the next generation. It is always best to transfer property
to the next generation in trust rather than outright. When the facts are
such that an accumulation trust is best, it is difficult to draft it in
a revocable living trust.
A stand-alone trust is an inter vivos trust created by the participant
as grantor; it can be revocable or irrevocable. It is nominally funded
during the grantor’s life and will receive retirement plan benefits
upon the death of the participant by means of properly drafted beneficiary
designations. In Illinois, the stand-alone trust is a handy asset protection solution.
Understanding retirement planning enables the planning team to help clients
pass more wealth to their loved ones, integrate a client’s IRA with
their estate planning, maximize continued tax-deferred growth, protect
and grow IRA savings for their families, and take advantage of the rules
applying to separate accounts governing IRAs and qualified plans so that
each beneficiary can control his or her own inheritance.
Like other aspects of planning, it is helpful to review client retirement
planning objectives and beneficiary designations frequently to ensure
they coordinate with the client’s estate planning needs.