If you own an IRA account, you will usually name a person as beneficiary to receive the IRA at the time of your death. In most instances, the beneficiary can roll the IRA over into an IRA in the beneficiary’s name and also defer taxes by withdrawing the funds over time. When a beneficiary is a responsible adult and when you want that person to be able to access the full IRA account, this is a good plan. The IRA can be rolled over into an inherited IRA and the beneficiary can withdraw the funds over time, thereby reducing taxes. The person can also name a beneficiary for the IRA to go to upon his or her death. In a situation where spouses have been married for a long time and have responsible adult children together, this works well.
But what happens if you want your spouse to receive annual income from the IRA but upon your spouse’s death for the remainder to go to your children from a prior marriage? With most financial institutions, if the IRA rolls-over to your spouse upon your death, then your spouse can access the entire IRA and can name the ultimate beneficiary to receive the IRA upon your spouse’s death. The institutions do not allow the owner of the IRA to put constraints or limitations if the beneficiary named is an individual. In other words, with the IRA administrator, it is bascially “all or nothing.”
What is needed in this instance is a planning tool which allows the IRA distributions and beneficiary designations to be controlled upon the death of the owner. The answer is what some lawyers call a “see-through trust.” Our firm calls this type of see-through trust a “Retirement Trust.”
In essence, the Retirement Trust is set up with special provisions to allow the trust to be named as primary beneficiary of the IRA. The Retirement Trust provides that the funds from the IRA are to be taken out according to the beneficiary’s required minimum distribution (“RMD’) schedule rather than all at once. In doing so, payment of taxes is deferred and “stretched out” over time. It also means that if the IRA is to go to the spouse, the spouse cannot deplete it all at once nor can he or she leave the remaining IRA funds to someone other than the original owner desired.
An example may help demonstrate the advantage of the Retirement Trust. Tom and Carol are married-a second time for each. Tom has two adult children and Carol has one child, each from their first marriage. Tom also has a sizable IRA from which he wants Carol to receive annual distributions but not the entire amount of the IRA account. Tom also wants what remains of the IRA at Carol’s death to go to his children. By if Tom names Carol as beneficiary of his IRA directly, upon Tom’s death Carol can roll it into her own IRA and from there she can do with it as she likes. She can cash it in and spend the money or she can leave it in the roll-over IRA and designate her own child as ultimate beneficiary. This would not be Tom’s desire and while he loves Carol, Tom wants to protect both her and his children.
In this case, Tom could establish a Retirement Trust and could make it the primary beneficiary of his IRA. The Retirement Trust can name Carol as primary beneficiary and Tom’s children as secondary beneficiaries. Upon Tom’s death, the Trustee of the Retirement Trust can receive RMDs annually based on Carol’s life expectancy and can distribute those funds to Carol. However, Carol would not be able to access the funds in the IRA all at once and she cannot designate her own beneficiaries upon her death. Instead, on her death the remaining IRA funds would go to Tom’s children.
Setting up a Retirement Trust is complex and should be done by an experienced estate planning attorney. As with most estate planning, this is not something that the “do-it-yourselfer” should undertake!