Retirement Planning

IRA Legacy Trusts

Retirement plans are often one of the most significant and most overlooked assets in estate planning. Beneficiary designations are some of the most important decisions you will make. Without planning, your beneficiaries may decide to “cash in” their IRA inheritance and be subjected to immediate tax liability on the withdrawal. Even worse, they may lose the inherited IRA proceeds to creditors or as part of a divorce.

Naming your revocable living trust as a beneficiary may cause problems with the IRA’s stretch out option depending upon tax and legal variables. A solution to these and many other problems is the IRA Legacy Trust. Through this specialized trust, your estate planning may avoid potential pitfalls.

Retirement plans follow a complex set of rules and regulations that dictate how long accounts can be held before cashing out (Minimum Distribution Rules). We can assist you in designing an IRA Legacy Trust that will allow or force your beneficiaries to “stretch out” the tax deferred growth over the beneficiary’s lifetime.

Distributions from Retirement Planning
Traditional IRA Distribution Flow Chart (click here)
Planning for Tax-Qualified Plans

Planning for tax-qualified plans, which includes IRAs, 401(k)s and qualified retirement plans, requires a careful examination of the potential taxes that impact these assets. Unlike most other assets that receive a “basis step up” to current fair market value upon the owner’s death, IRAs, 401(k)s and other qualified retirement plans do not step-up to the date-of-death value. Therefore, beneficiaries who receive these assets do so subject to income tax. If your estate is subject to estate tax, the value of these assets may be further reduced by the estate tax. If you name grandchildren or younger generations as beneficiaries, these assets may additionally be reduced by the generation- skipping transfer tax. Together these assets may be reduced by 70% or more.

  • There are several strategies available to help reduce the impact of these taxes:
  • Structure accounts to provide the longest term payout possible;
  • Name a retirement trust as beneficiary;
  • Take the money out during lifetime and pay the income tax, then gift the remaining cash either outright or through an irrevocable life insurance trust;
  • Name a Charitable Remainder Trust as beneficiary with a lifetime payout to your surviving spouse.
  • The remaining assets would pass to charity at the death of your spouse; and
  • Give the accounts to charity at death.

Structure Accounts to Provide the Longest Term Payout Possible.

Structuring the accounts to provide the longest term payout possible is the most simple and therefore the most common option. With this strategy you name beneficiaries in such a way that requires them to withdraw the least amount possible as required minimum distributions, or those distributions that must be made in order to avoid significant penalties. To achieve this maximum “stretch-out,” you should name individuals who are young (e.g., children or grandchildren, although there are special considerations when naming grandchildren or younger generations) as the designated beneficiary of your tax-qualified plans. Significantly, the beneficiary should take only those minimum distributions that are required by law. The younger the beneficiary, the smaller these required minimum distributions and the tax deferral opportunity.

This may be accomplished by naming the beneficiaries individually or by directly naming their shares of a trust. Frequently, the surviving spouse is named as the primary beneficiary so that he or she may roll over the account into the surviving spouse’s name and treat it as his or her own account. Alternatively, if you are concerned about the loss of creditor or divorce protection by naming the surviving spouse individually, you can name a specifically designed trust for the survivor’s benefit.

Name a Retirement Trust as Beneficiary to Mandate the Longest Term Payout Possible.

Naming a beneficiary outright to accomplish tax deferral with a tax-qualified plan has several disadvantages. First, if the beneficiary is very young, the distributions must be paid to a conservator; if the beneficiary has no conservator, a court must appoint one. Another disadvantage is the potential loss of creditor protection or bloodline protection, particularly where the named beneficiary is the surviving spouse. A third practical disadvantage is that many beneficiaries take distributions much larger than the required minimum distributions, often consuming this “found money” in only a couple of years. We refer to this as the “blowout” option that occurs all too frequently.

However, by naming a specialized trust as the beneficiary of your tax-qualified plans, you can require that the beneficiary defer the income and that these assets remain protected from creditors or a former son or daughter-in-law. A stand-alone Retirement Trust (separate from your revocable living trust and other trusts) can help accomplish your objectives while also achieving the maximum tax deferral permitted under the law.

Take Distributions During Lifetime and Pay the Income Tax, Then Gift The Remaining Cash Either Outright or Through an Irrevocable Life Insurance Trust.

Another option is to take distributions during lifetime and pay the income tax, then gift the remaining cash either outright via lifetime giving or through an irrevocable life insurance trust. If you desire to make the gifts through an irrevocable life insurance trust, this strategy is more effective if you are in good health and able to obtain life insurance at reasonable rates. Unlike the IRA or retirement plan, the beneficiaries will receive the life insurance proceeds free of income and estate tax and, under certain circumstances, free of generation-skipping transfer tax.

Name a Charitable Remainder Trust as Beneficiary With a Lifetime Payout to Your Surviving Spouse; the Remaining Assets Pass to Charity at the Death of the Your Spouse.

Yet another option is to leave the accounts to a Charitable Remainder Trust (“CRT”), a type of trust specifically authorized by the Internal Revenue Code. This type of trust permits you to transfer ownership of assets to the trust in exchange for an income stream to the person or persons of your choice (typically you or, if you are married, your spouse, or you and your spouse) for life or for a specified term of up to 20 years. With the most common type of Charitable Remainder Trust, at the end of the term, the balance of the trust property (the “remainder interest”) is transferred to a specified charity or charities. Charitable Remainder Trusts reduce estate taxes by transferring ownership of assets that otherwise would be counted for estate tax purposes.

Naming a Charitable Remainder Trust can allow the accounts to pass free of any estate taxes and will pay to the surviving spouse an annual income stream, either in a specified dollar amount or the lesser of the trust income or a percentage of the net fair market value of the assets.

Distribute the Accounts to Charity at Death

Another option is to transfer a retirement account to charity at your death or at the death of the survivor of you and your spouse. This strategy is particularly attractive for the charitably inclined. As a tax exempt entity, a qualified charity does not pay income tax and therefore receives qualified retirement plans free of income tax, whereas individual beneficiaries are subject to future income taxes.

In other words, if upon withdrawal a beneficiary is in a 35% tax bracket, a $100,000 IRA is worth only $65,000 in his or her hands, but worth the full $100,000 if given to charity. Therefore, it may make sense to transfer retirement assets to charity and to give other assets not subject to income tax and which receive a step-up in basis to their date-of-death value at your death to non-charitable beneficiaries.

These are only a few of the more common planning solutions for tax-qualified plans. The right solution for you will depend upon your particular goals and objectives as well as your particular circumstances.

For information on how to get started on your estate plan visit our Estate Planning Process page.


We were very pleased with the level of expertise available at Davis Schilken. It enabled us to feel confident that we were presented all options. The process was efficient and allowed us to complete our estate planning effectively and efficiently. - W&L R.
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